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Is the Volatility of the Market Price of Risk due to Intermittent Portfolio Re-balancing?

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Author Info
Yi-Li Chien
Harold L. Cole
Hanno Lustig

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Abstract

Our paper examines whether intermittent portfolio re-balancing on the part of some stock market investors can help to explain the counter-cyclical volatility of aggregate risk compensation in financial markets. To answer this question, we set up an incomplete markets model in which CRRA-utility investors are subject to aggregate and idiosyncratic shocks and have heterogeneous trading technologies. In our model, a large mass of passive investors do not re-balance their portfolio shares in response to aggregate shocks, while a smaller mass of active investors adjust their portfolio each period to respond to changes in the investment opportunity set. We find that intermittent re-balancers amplify the effect of aggregate shocks on the time variation in risk premia by a factor of three in a calibrated version of our model.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15382.

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Date of creation: Sep 2009
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Handle: RePEc:nbr:nberwo:15382

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G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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This page was last updated on 2009-11-25.

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