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Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices

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  • Yeung Lewis Chan
  • Leonid Kogan
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    Abstract

    We analyze a general equilibrium exchange economy with a continuum of agents who have 'catching up with the Joneses' preferences and differ only with respect to the curvature of their utility functions. While individual risk aversion does not change over time, dynamic redistribution of wealth among the agents leads to countercyclical time variation in the Sharpe ratio of stock returns. We show that both the conditional risk premium and the return volatility are negatively related to the level of stock prices, as observed empirically. Therefore, our model exhibits many of the empirically observed properties of aggregate stock returns, e.g., patterns of autocorrelation in returns, the 'leverage effect' in return volatility and long-horizon return predictability. For comparison, otherwise similar representative agent economies with the same type of preferences exhibit counter-factual behavior, e.g., a constant Sharpe ratio of returns and procyclical risk premium and return volatility.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8607.

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    Date of creation: Nov 2001
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    Publication status: published as Chan, Yeung Lewis and Leonid Kogan. "Catching Up With The Joneses: Heterogeneous Preferences And The Dynamics Of Asset Prices," Journal of Political Economy, 2002, v110(6,Dec), 1255-1285.
    Handle: RePEc:nbr:nberwo:8607

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    Cited by:
    1. Yu Chen & Thomas Cosimano & Alex Himonas, 2008. "Solving an asset pricing model with hybrid internal and external habits, and autocorrelated Gaussian shocks," Annals of Finance, Springer, vol. 4(3), pages 305-344, July.
    2. Cochrane, John H., 2005. "Financial Markets and the Real Economy," Foundations and Trends(R) in Finance, now publishers, vol. 1(1), pages 1-101, July.
    3. David S. Bates, 2001. "The Market for Crash Risk," NBER Working Papers 8557, National Bureau of Economic Research, Inc.
    4. Martin B. Haugh & Leonid Kogan & Jiang Wang, 2003. "Evaluating Portfolio Policies: A Duality Approach," NBER Working Papers 9861, National Bureau of Economic Research, Inc.

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