Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices

38 Pages Posted: 17 Nov 2001 Last revised: 25 Oct 2010

See all articles by Yeung Lewis Chan

Yeung Lewis Chan

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Leonid Kogan

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: November 2001

Abstract

We analyze a general equilibrium exchange economy with a continuum of agents who have 'catching up with the Joneses' preferences and differ only with respect to the curvature of their utility functions. While individual risk aversion does not change over time, dynamic redistribution of wealth among the agents leads to countercyclical time variation in the Sharpe ratio of stock returns. We show that both the conditional risk premium and the return volatility are negatively related to the level of stock prices, as observed empirically. Therefore, our model exhibits many of the empirically observed properties of aggregate stock returns, e.g., patterns of autocorrelation in returns, the 'leverage effect' in return volatility and long-horizon return predictability. For comparison, otherwise similar representative agent economies with the same type of preferences exhibit counter-factual behavior, e.g., a constant Sharpe ratio of returns and procyclical risk premium and return volatility.

Suggested Citation

Chan, Yeung Lewis and Kogan, Leonid, Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices (November 2001). NBER Working Paper No. w8607. Available at SSRN: https://ssrn.com/abstract=291282

Yeung Lewis Chan (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

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Leonid Kogan

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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