Asset Prices with Wealth Dispersion
31 Pages Posted: 4 Mar 2021 Last revised: 6 Oct 2021
Date Written: January 7, 2021
With overlapping generations and heterogeneous risk aversion there is no unique relation between aggregate risk aversion and the real rate of interest, and this type of endogenous “noise” cannot arise in an economy where agents live forever. Our framework accommodates many agent types and the noise emerges precisely because all (but one) consumption shares drive the economy. Adding wealth dispersion to aggregate risk aversion sufficiently summarizes the rich dynamics of the model. Consistent with the model, we construct “level” and “slope” factors that do not require knowledge about agents’ risk aversion to predict excess returns.
Keywords: Heterogeneous Risk Aversion, Overlapping Generations, Consumption Share Weighted Variance of the Risk-Tolerance, Return Predictability
JEL Classification: E2, G10, G11, G12
Suggested Citation: Suggested Citation