Heterogeneity in Preferences and Asset Market Outcomes

21 Pages Posted: 21 Jan 2005

See all articles by David A. Chapman

David A. Chapman

McIntire School, University of Virginia

Valery Polkovnichenko

Board of Governors of the Federal Reserve System

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

Chapman, David A. and Polkovnichenko, Valery, Heterogeneity in Preferences and Asset Market Outcomes (November 2006). Available at SSRN: https://ssrn.com/abstract=652085 or http://dx.doi.org/10.2139/ssrn.652085

David A. Chapman

McIntire School, University of Virginia ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States

HOME PAGE: http://https://sites.google.com/site/davidchapmanswebsite/

Valery Polkovnichenko (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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