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Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Rebalancing?


  • YiLi Chien
  • Harold Cole
  • Hanno Lustig


Our paper examines whether the failure of unsophisticated investors to rebalance their portfolios can help to explain the countercyclical volatility of aggregate risk compensation in financial markets. To answer this question, we set up a model in which a large mass of investors do not rebalance their portfolio shares in response to aggregate shocks, while a smaller mass of active investors do. We find that intermittent rebalancers 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. (JEL D14, E32, G11, G12)

Suggested Citation

  • YiLi Chien & Harold Cole & Hanno Lustig, 2012. "Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Rebalancing?," American Economic Review, American Economic Association, vol. 102(6), pages 2859-2896, October.
  • Handle: RePEc:aea:aecrev:v:102:y:2012:i:6:p:2859-96

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    Cited by:

    1. Edison Yu, 2013. "Dynamic market participation and endogenous information aggregation," Working Papers 13-42, Federal Reserve Bank of Philadelphia.
    2. Fernando Alvarez & Luigi Guiso & Francesco Lippi, 2012. "Durable Consumption and Asset Management with Transaction and Observation Costs," American Economic Review, American Economic Association, vol. 102(5), pages 2272-2300, August.
    3. David, Joel M. & Simonovska, Ina, 2016. "Correlated beliefs, returns, and stock market volatility," Journal of International Economics, Elsevier, vol. 99(S1), pages 58-77.
    4. Chien, YiLi & Cole, Harold L. & Lustig, Hanno, 2014. "Implications of heterogeneity in preferences, beliefs and asset trading technologies for the macroeconomy," Working Papers 2014-14, Federal Reserve Bank of St. Louis.
    5. Orazio P. Attanasio & Guglielmo Weber, 2010. "Consumption and Saving: Models of Intertemporal Allocation and Their Implications for Public Policy," Journal of Economic Literature, American Economic Association, vol. 48(3), pages 693-751, September.
    6. Gao, Xiaodan & Hnatkovska, Viktoria & Marmer, Vadim, 2014. "Limited participation in international business cycle models: A formal evaluation," Journal of Economic Dynamics and Control, Elsevier, vol. 39(C), pages 255-272.
    7. Carvalho, Carlos & Schwartzman, Felipe, 2015. "Selection and monetary non-neutrality in time-dependent pricing models," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 141-156.
    8. Jędrzej Białkowski & Ehud I. Ronn, 2017. "The Global Equity Premium Revisited: What Human Rights Imply for Assets’ Purchasing Power," Working Papers in Economics 17/19, University of Canterbury, Department of Economics and Finance.
    9. Chien, YiLi, 2015. "The Welfare Cost of Business Cycles with Heterogeneous Trading Technologies," Review, Federal Reserve Bank of St. Louis, vol. 97(1), pages 67-85.
    10. Yili Chien & Harold Cole & Hanno Lustig, 2016. "Implications of Heterogeneity in Preferences, Beliefs and Asset Trading Technologies in an Endowment Economy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 20, pages 215-239, April.
    11. Cespa, Giovanni & Vives, Xavier, 2016. "High Frequency Trading and Fragility," CEPR Discussion Papers 11732, C.E.P.R. Discussion Papers.
    12. Adrian Buss & Bernard Dumas, 2015. "The Dynamic Properties of Financial-Market Equilibrium with Trading Fees," NBER Working Papers 21421, National Bureau of Economic Research, Inc.
    13. Bacchetta, Philippe & van Wincoop, Eric, 2017. "Gradual Portfolio Adjustment: Implications for Global Equity Portfolios and Returns," CEPR Discussion Papers 11983, C.E.P.R. Discussion Papers.
    14. Campanale, Claudio & Fugazza, Carolina & Gomes, Francisco, 2015. "Life-cycle portfolio choice with liquid and illiquid financial assets," Journal of Monetary Economics, Elsevier, vol. 71(C), pages 67-83.
    15. Buss, Adrian & Dumas, Bernard J, 2015. "Trading Fees and Slow-Moving Capital," CEPR Discussion Papers 10737, C.E.P.R. Discussion Papers.
    16. Finocchiaro, Daria, 2011. "Inattention, wealth inequality and equilibrium asset prices," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 146-155, March.
    17. Campanale, Claudio & Fugazza, Carolina & Gomes, Francisco J, 2015. "Life-Cycle Portfolio choice with Liquid and Illiquid Assets," CEPR Discussion Papers 10369, C.E.P.R. Discussion Papers.
    18. Elías Albagli, 2013. "Investment Horizons and Asset Prices under Asymmetric Information," Working Papers Central Bank of Chile 709, Central Bank of Chile.
    19. Kurt F. Lewis & Francis A. Longstaff & Lubomir Petrasek, 2017. "Asset Mispricing," NBER Working Papers 23231, National Bureau of Economic Research, Inc.
    20. Philippe Bacchetta, 2017. "Slow Moving Capital: Evidence from Global Equity Portfolios," 2017 Meeting Papers 1166, Society for Economic Dynamics.

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates


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