IDEAS home Printed from https://ideas.repec.org/a/ucp/jpolec/v110y2002i6p1255-1285.html
   My bibliography  Save this article

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

Author

Listed:
  • Yeung Lewis Chan
  • Leonid Kogan

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. Therefore, our model exhibits many of the empirically observed properties of aggregate stock returns, for example, patterns of autocorrelation in returns, the "leverage effect" in return volatility, and long-horizon return predictability.

Suggested Citation

  • Yeung Lewis Chan & Leonid Kogan, 2002. "Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1255-1285, December.
  • Handle: RePEc:ucp:jpolec:v:110:y:2002:i:6:p:1255-1285
    DOI: 10.1086/342806
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1086/342806
    File Function: main text
    Download Restriction: Access to the online full text or PDF requires a subscription.
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    2. Constantinides, George M & Duffie, Darrell, 1996. "Asset Pricing with Heterogeneous Consumers," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 219-240, April.
    3. Kjetil Storesletten & Chris Telmer & Amir Yaron, 2007. "Asset Pricing with Idiosyncratic Risk and Overlapping Generations," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(4), pages 519-548, October.
    4. Basak, Suleyman & Cuoco, Domenico, 1998. "An Equilibrium Model with Restricted Stock Market Participation," Review of Financial Studies, Society for Financial Studies, vol. 11(2), pages 309-341.
    5. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
    6. Harvey, Campbell R., 2001. "The specification of conditional expectations," Journal of Empirical Finance, Elsevier, vol. 8(5), pages 573-637, December.
    7. Campbell, John Y. & Hentschel, Ludger, 1992. "No news is good news *1: An asymmetric model of changing volatility in stock returns," Journal of Financial Economics, Elsevier, vol. 31(3), pages 281-318, June.
    8. Yeung Lewis Chan & Leonid Kogan, 2002. "Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1255-1285, December.
    9. repec:fth:harver:1421 is not listed on IDEAS
    10. Alon Brav & George M. Constantinides & Christopher C. Geczy, 2002. "Asset Pricing with Heterogeneous Consumers and Limited Participation: Empirical Evidence," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 793-824, August.
    11. Bollerslev, Tim & Engle, Robert F. & Nelson, Daniel B., 1986. "Arch models," Handbook of Econometrics, in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 49, pages 2959-3038, Elsevier.
    12. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
    13. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    14. John Heaton & Deborah J. Lucas, 2000. "Stock prices and fundamentals," Proceedings, Federal Reserve Bank of San Francisco, issue Apr.
    15. Mankiw, N. Gregory, 1986. "The equity premium and the concentration of aggregate shocks," Journal of Financial Economics, Elsevier, vol. 17(1), pages 211-219, September.
    16. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
    17. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
    18. Ferson, Wayne E. & Constantinides, George M., 1991. "Habit persistence and durability in aggregate consumption: Empirical tests," Journal of Financial Economics, Elsevier, vol. 29(2), pages 199-240, October.
    19. Gali, Jordi, 1994. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice, and Asset Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(1), pages 1-8, February.
    20. Detemple Jerome & Murthy Shashidhar, 1994. "Intertemporal Asset Pricing with Heterogeneous Beliefs," Journal of Economic Theory, Elsevier, vol. 62(2), pages 294-320, April.
    21. Jiang Wang, 1993. "A Model of Intertemporal Asset Prices Under Asymmetric Information," Review of Economic Studies, Oxford University Press, vol. 60(2), pages 249-282.
    22. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-487, June.
    23. Schwert, G William, 1989. " Why Does Stock Market Volatility Change over Time?," Journal of Finance, American Finance Association, vol. 44(5), pages 1115-1153, December.
    24. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-543, June.
    25. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-384, March.
    26. Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
    27. Hindy, Ayman & Huang, Chi-fu & Zhu, Steven H., 1997. "Optimal consumption and portfolio rules with durability and habit formation," Journal of Economic Dynamics and Control, Elsevier, vol. 21(2-3), pages 525-550.
    28. Bakshi, Gurdip S & Chen, Zhiwu, 1996. "The Spirit of Capitalism and Stock-Market Prices," American Economic Review, American Economic Association, vol. 86(1), pages 133-157, March.
    29. Sundaresan, Suresh M, 1989. "Intertemporally Dependent Preferences and the Volatility of Consumption and Wealth," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 73-89.
    30. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    31. Nelson, Charles R & Kim, Myung J, 1993. "Predictable Stock Returns: The Role of Small Sample Bias," Journal of Finance, American Finance Association, vol. 48(2), pages 641-661, June.
    32. Detemple, Jerome B & Zapatero, Fernando, 1991. "Asset Prices in an Exchange Economy with Habit Formation," Econometrica, Econometric Society, vol. 59(6), pages 1633-1657, November.
    33. Hindy, Ayman & Huang, Chi-fu, 1993. "Optimal Consumption and Portfolio Rules with Durability and Local Substitution," Econometrica, Econometric Society, vol. 61(1), pages 85-121, January.
    34. Harl E. Ryder & Geoffrey M. Heal, 1973. "Optimal Growth with Intertemporally Dependent Preferences," Review of Economic Studies, Oxford University Press, vol. 40(1), pages 1-31.
    35. Dybvig, Philip H & Rogers, L C G, 1997. "Recovery of Preferences from Observed Wealth in a Single Realization," Review of Financial Studies, Society for Financial Studies, vol. 10(1), pages 151-174.
    36. Heaton, John, 1995. "An Empirical Investigation of Asset Pricing with Temporally Dependent Preference Specifications," Econometrica, Econometric Society, vol. 63(3), pages 681-717, May.
    37. Grossman, Sanford J & Zhou, Zhongquan, 1996. "Equilibrium Analysis of Portfolio Insurance," Journal of Finance, American Finance Association, vol. 51(4), pages 1379-1403, September.
    38. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
    39. Cox, John C. & Huang, Chi-fu, 1989. "Optimal consumption and portfolio policies when asset prices follow a diffusion process," Journal of Economic Theory, Elsevier, vol. 49(1), pages 33-83, October.
    40. Wang, Jiang, 1994. "A Model of Competitive Stock Trading Volume," Journal of Political Economy, University of Chicago Press, vol. 102(1), pages 127-168, February.
    41. Hindy, Ayman & Huang, Chi-fu, 1992. "Intertemporal Preferences for Uncertain Consumption: A Continuous Time Approach," Econometrica, Econometric Society, vol. 60(4), pages 781-801, July.
    42. Dumas, Bernard, 1989. "Two-Person Dynamic Equilibrium in the Capital Market," Review of Financial Studies, Society for Financial Studies, vol. 2(2), pages 157-188.
    43. Abel, Andrew B., 1999. "Risk premia and term premia in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 3-33, February.
    44. Constantinides, George M, 1982. "Intertemporal Asset Pricing with Heterogeneous Consumers and without Demand Aggregation," The Journal of Business, University of Chicago Press, vol. 55(2), pages 253-267, April.
    45. Jiang, Wang, 1996. "The term structure of interest rates in a pure exchange economy with heterogeneous investors," Journal of Financial Economics, Elsevier, vol. 41(1), pages 75-110, May.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. John Y. Campbell, 2000. "Asset Pricing at the Millennium," Journal of Finance, American Finance Association, vol. 55(4), pages 1515-1567, August.
    2. George M. Constantinides, 2002. "Rational Asset Prices," NBER Working Papers 8826, National Bureau of Economic Research, Inc.
    3. Suresh M. Sundaresan, 2000. "Continuous‐Time Methods in Finance: A Review and an Assessment," Journal of Finance, American Finance Association, vol. 55(4), pages 1569-1622, August.
    4. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887, Elsevier.
    5. 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.
    6. Kris Jacobs, 2002. "The Rate of Risk Aversion May Be Lower Than You Think," CIRANO Working Papers 2002s-08, CIRANO.
    7. John Donaldson & Rajnish Mehra, 2007. "Risk Based Explanations of the Equity Premium," NBER Working Papers 13220, National Bureau of Economic Research, Inc.
    8. Ludvigson, Sydney C., 2013. "Advances in Consumption-Based Asset Pricing: Empirical Tests," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 799-906, Elsevier.
    9. George M. Constantinides, 2006. "Market Organization And The Prices Of Financial Assets," Manchester School, University of Manchester, vol. 74(s1), pages 1-23, September.
    10. Kris Jacobs & Kevin Q. Wang, 2002. "Idiosyncratic Consumption Risk and the Cross-Section of Asset Returns," CIRANO Working Papers 2002s-11, CIRANO.
    11. Andrei Semenov, 2003. "High-Order Consumption Moments and Asset Pricing," Working Papers 2003_4, York University, Department of Economics, revised Jan 2005.
    12. Munk, Claus, 2015. "Financial Asset Pricing Theory," OUP Catalogue, Oxford University Press, number 9780198716457.
    13. Li, George, 2008. "Aggregate stock market behavior and investors' low risk aversion," Journal of Economic Dynamics and Control, Elsevier, vol. 32(7), pages 2349-2369, July.
    14. Kris Jacobs, 2001. "Estimating Nonseparable Preference Specifications for Asset Market Participants," CIRANO Working Papers 2001s-12, CIRANO.
    15. Longstaff, Francis A. & Piazzesi, Monika, 2004. "Corporate earnings and the equity premium," Journal of Financial Economics, Elsevier, vol. 74(3), pages 401-421, December.
    16. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    17. M. Fatih Guvenen, 2003. "A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity?," RCER Working Papers 499, University of Rochester - Center for Economic Research (RCER).
    18. Francisco Gomes & Alexander Michaelides, 2003. "Portfolio Choice With Internal Habit Formation: A Life-Cycle Model With Uninsurable Labor Income Risk," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 729-766, October.
    19. Alon Brav & George M. Constantinides & Christopher C. Geczy, 2002. "Asset Pricing with Heterogeneous Consumers and Limited Participation: Empirical Evidence," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 793-824, August.
    20. Sialm, Clemens, 2006. "Stochastic taxation and asset pricing in dynamic general equilibrium," Journal of Economic Dynamics and Control, Elsevier, vol. 30(3), pages 511-540, March.

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ucp:jpolec:v:110:y:2002:i:6:p:1255-1285. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Journals Division). General contact details of provider: https://www.journals.uchicago.edu/JPE .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.