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Asset prices in a Huggett economy

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Author Info

  • Krusell, Per
  • Mukoyama, Toshihiko
  • Smith Jr., Anthony A.

Abstract

This paper explores asset pricing in economies where there is no direct insurance against idiosyncratic risks but other assets can be used for self-insurance, subject to exogenously-imposed borrowing limits. We analyze an endowment economy, based on Huggett (1993) [11], both with and without aggregate risk. Our main innovation is that we obtain full analytical tractability by studying the case with "maximally tight" borrowing constraints. We illustrate by looking at riskless bonds, equity, and the term structure of interest rates, and we show that the model can reproduce many features of observed asset prices when idiosyncratic risks are quantitatively reasonable.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 146 (2011)
Issue (Month): 3 (May)
Pages: 812-844

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Handle: RePEc:eee:jetheo:v:146:y:2011:i:3:p:812-844

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Web page: http://www.elsevier.com/locate/inca/622869

Related research

Keywords: Incomplete markets Asset prices Borrowing constraints Equity premium;

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References

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  1. Fernando Alvarez & Urban J. Jermann, 1999. "Quantitative asset pricing implications of endogenous solvency constraints," Working Papers 99-5, Federal Reserve Bank of Philadelphia.
  2. N. Gregory Mankiw, 1986. "The Equity Premium and the Concentration of Aggregate Shocks," NBER Working Papers 1788, National Bureau of Economic Research, Inc.
  3. Per Krusell & Anthony A. Smith, Jr., . "Income and Wealth Heterogeneity, Portfolio Choice, and Equilibrium Asset Returns," GSIA Working Papers 1997-45, Carnegie Mellon University, Tepper School of Business.
  4. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
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  6. Krusell, P & Smith Jr, A-A, 1995. "Income and Wealth Heterogeneity in the Macroeconomic," RCER Working Papers 399, University of Rochester - Center for Economic Research (RCER).
  7. Heaton, John & Lucas, Deborah, 1992. "The effects of incomplete insurance markets and trading costs in a consumption-based asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 601-620.
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  10. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
  11. Sylvain Leduc, 1998. "Incomplete Markets, Borrowing Constraints, and the Foreign Exchange Risk Premium," Research in Economics 98-06-050e, Santa Fe Institute.
  12. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
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  16. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
  17. Bewley, Truman, 1983. "A Difficulty with the Optimum Quantity of Money," Econometrica, Econometric Society, vol. 51(5), pages 1485-504, September.
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  19. Albert Marcet & Kenneth J. Singleton, 1990. "Equilibrium asset prices and savings of heterogeneous agents in the presence of incomplete markets and portfolio constraints," Economics Working Papers 319, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 1998.
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  22. Ana Castaneda & Javier Diaz-Gimenez & Jose-Victor Rios-Rull, 2003. "Accounting for the U.S. Earnings and Wealth Inequality," Journal of Political Economy, University of Chicago Press, vol. 111(4), pages 818-857, August.
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Citations

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Cited by:
  1. Le Grand, F. & Ragot, X., 2010. "Prices and volumes of options: A simple theory of risk sharing when markets are incomplete," Working papers 302, Banque de France.
  2. Edouard Challe & François Le Grand & Xavier Ragot, 2013. "Incomplete markets, liquidation risk, and the term structure of interest rates," PSE Working Papers hal-00843147, HAL.
  3. Cordoba, Juan Carlos & Liu, Xiying, 2014. "Altruism, Fertility and Risk," Staff General Research Papers 37481, Iowa State University, Department of Economics.
  4. Volker Tjaden & Ralph Lütticke & Lien Pham & Christian Bayer, 2013. "Household Income Risk, Nominal Frictions, and Incomplete Markets," 2013 Meeting Papers 1270, Society for Economic Dynamics.
  5. Corbae, Dean & Marimon, Ramon, 2011. "Introduction to Incompleteness and Uncertainty in Economics," Journal of Economic Theory, Elsevier, vol. 146(3), pages 775-784, May.

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