Heterogeneous-Agent Asset Pricing

Abstract

When does idiosyncratic consumption risk matter for asset returns? This paper provides an answer in a comprehensive framework with jumps and heterogeneous recursive preferences. While cross-sectional consumption risk always affects the riskfree interest rate and equity volatility, it is irrelevant to risk premia in partial equilibrium if and only if all agents have additively separable preferences. It is irrelevant to risk premia in general equilibrium if and only if all agents have identical power utility and cross-sectional risk is uncorrelated with aggregate consumption risk. The paper also solves explicitly for asset prices in a tractable special case of isoelastic recursive preferences. To illustrate the applicability of the framework, I solve a general equilibrium model in which recursive-utility agents can only invest in a riskfree bond, a stock, and their own inalienable human capital, subject to countercyclical risk of an idiosyncratic disaster.

Keywords: Asset pricing, Incomplete markets, Heterogeneous agents, Human capital

JEL Classification: E21, E24, E32, E44, G11, G12, J24