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Comparative Statics of Asset Prices

  • Theodoros Diasakos

In a single-commodity, pure-exchange, representative-agent economy with many Lucas' trees whose dividends are geometric Brownian motions, I study the comparative statics of the prices of these assets with respect to the current Brownian realization. As is well-known, due to wealth effects, a security's price may vary with the realization of a Brownian motion even when its dividend is independent of it. Yet, a crucial component of wealth effects has hitherto been ignored by the literature: changes in wealth do not alter only the agent's risk aversion, but also her perceived "riskiness" of the security. This enhances the extent to which market-clearing leads to endogenously-generated correlation across asset prices and returns, over and above that induced by correlation between payoffs, giving the appearance of "contagion." I establish also a necessary and sufficient condition for the securities market to be dynamically complete. Being independent of the utility function of the representative agent, it applies even in the presence of many heterogenous agents.

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Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 72.

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Length: 84 pages
Date of creation: 2008
Date of revision: 2011
Handle: RePEc:cca:wpaper:72
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  1. Lagunoff, Roger & Schreft, Stacey L, 1999. "Financial Fragility with Rational And Irrational Exuberance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 531-60, August.
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  3. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, 08.
  4. Michael W. Brandt & Francis X. Diebold, 2001. "A No-Arbitrage Approach to Range-Based Estimation of Return Covariances and Correlations," PIER Working Paper Archive 03-013, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 01 Apr 2003.
  5. John H. Cochrane & Francis A. Longstaff & Pedro Santa-Clara, 2003. "Two Trees: Asset Price Dynamics Induced by Market Clearing," Levine's Bibliography 666156000000000355, UCLA Department of Economics.
  6. Tobias J. Moskowitz, 2003. "An Analysis of Covariance Risk and Pricing Anomalies," Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 417-457.
  7. Gropp, Reint & Moerman, Gerard, 2003. "Measurement of contagion in banks' equity prices," Working Paper Series 0297, European Central Bank.
  8. Bhamra, Harjoat S. & Uppal, Raman, 2006. "The role of risk aversion and intertemporal substitution in dynamic consumption-portfolio choice with recursive utility," Journal of Economic Dynamics and Control, Elsevier, vol. 30(6), pages 967-991, June.
  9. Ravi Bansal & Varoujan Khatachtrian & Amir Yaron, 2002. "Interpretable Asset Markets?," NBER Working Papers 9383, National Bureau of Economic Research, Inc.
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  11. Robert Anderson & Roberto Raimondo, 2005. "Market clearing and derivative pricing," Economic Theory, Springer, vol. 25(1), pages 21-34, 01.
  12. Laura E. Kodres & Matthew Pritsker, 2002. "A Rational Expectations Model of Financial Contagion," Journal of Finance, American Finance Association, vol. 57(2), pages 769-799, 04.
  13. He, Hua & Leland, Hayne, 1993. "On Equilibrium Asset Price Processes," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 593-617.
  14. Charalambos D Aliprantis & Gabriele Camera & Daniela Puzzello, 2007. "Contagion Equilibria in a Monetary Model," Econometrica, Econometric Society, vol. 75(1), pages 277-282, 01.
  15. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
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