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Quantitative Asset Pricing Implications of Endogenous Solvency Constraints

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Listed:
  • Alvarez, Fernando
  • Jermann, Urban J

Abstract

We study the asset pricing implications of an economy where solvency constraints are endogenously determined to deter agents from defaulting while allowing as much risk sharing as possible. We solve analytically for efficient allocations and for the corresponding asset prices, portfolio holdings, and solvency constraints for a simple example. Then we calibrate a more general model to U.S. aggregate as well as idiosyncratic income processes. We find equity premia, risk premia for long-term bonds, and Sharpe ratios of magnitudes similar to the U.S. data for low risk aversion and a low time-discount factor. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Alvarez, Fernando & Jermann, Urban J, 2001. "Quantitative Asset Pricing Implications of Endogenous Solvency Constraints," The Review of Financial Studies, Society for Financial Studies, vol. 14(4), pages 1117-1151.
    • Handle: RePEc:oup:rfinst:v:14:y:2001:i:4:p:1117-51
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General

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