Asset Pricing with Large Investors

We derive closed form expressions for equilibrium asset prices and liquidity in an economy populated by a finite number of large, strategic, risk averse investors. The model allows for arbitrary risk preferences, any number of assets, and an arbitrary distribution of asset payoffs. In equilibrium, assets are priced according to the standard consumption Euler equation plus a correction term accounting for market illiquidity (price impact), linked to an endogenous measure of systemic risk that puts a large weight on low consumption states. Wealth effects imply that price impact is generally asymmetric, which leads to the emergence of endogenous systemic assets: That is, assets whose sell-off triggers large moves in all security prices. Market liquidity is non-monotonic in funding liquidity and may decrease in the number of investors. In the presence of liquidity shortage, price impact becomes negative and gives rise to an illiquidity premium in asset prices.