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

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  • Yi-Li Chien
  • Harold L. Cole
  • Hanno Lustig

Abstract

Our paper examines whether the well-documented failure of unsophisticated investors to rebalance their portfolios can help to explain the enormous counter-cyclical volatility of aggregate risk compensation in financial markets. To answer this question, we set up a model in which CRRA-utility investors have heterogeneous trading technologies. In our model, a large mass of 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 these intermittent re-balancers more than double the effect of aggregate shocks on the time variation in risk premia by forcing active traders to sell more shares in good times and buy more shares in bad times.

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Bibliographic Info

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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Cited by:
  1. Gao, Xiaodan & Hnatkovska, Viktoria & Marmer, Vadim, 2012. "Limited Participation in International Business Cycle Models: A Formal Evaluation," Microeconomics.ca working papers vadim_marmer-2012-1, Vancouver School of Economics, revised 21 Dec 2013.
  2. Carlos Carvalho & Felipe Schwartzman, 2012. "Selection and monetary non-neutrality in time-dependent pricing models," Working Paper 12-09, Federal Reserve Bank of Richmond.
  3. ElĂ­as Albagli, 2013. "Investment Horizons and Asset Prices under Asymmetric Information," Working Papers Central Bank of Chile 709, Central Bank of Chile.
  4. Edison G. Yu, 2013. "Dynamic market participation and endogenous information aggregation," Working Papers 13-42, Federal Reserve Bank of Philadelphia.

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