Heterogeneity in Preferences and Asset Market Outcomes
21 Pages Posted: 21 Jan 2005
Date Written: November 2006
Abstract
We examine the impact of heterogeneity in preferences on asset prices in a setting where agents have rank-dependent expected utility. Endogenous limits to risk sharing arise naturally, with the more risk averse agents choosing to exit the market for the risky asset. This leads to economically significant variation in the equity premium and the risk free rate. Our results show that using a representative agent framework with non-expected utility preferences can be misleading precisely because it ignores these important endogenous risk sharing effects.
Keywords: Asset Prices, Aggregation, Rank-Dependent Expected Utility
JEL Classification: G12
Suggested Citation: Suggested Citation
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