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Habits and Leverage

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  • Santos, Tano
  • Veronesi, Pietro

Abstract

Many stylized facts of leverage, trading, and asset prices follow from a frictionless general equilibrium model that features agents' heterogeneity in endowments and habit preferences. Our model predicts that aggregate debt increases in good times when stock prices are high, return volatility is low, and levered agents enjoy a "consumption boom". Our model is consistent with poorer agents borrowing more and with recent evidence on intermediaries' leverage being a priced factor of asset returns. In crisis times, levered agents strongly deleverage by "fire selling" their risky assets as asset prices drop. Yet, consistently with the data, their debt-to-wealth ratios increase because their wealth decline faster due to higher discount rates.

Suggested Citation

  • Santos, Tano & Veronesi, Pietro, 2016. "Habits and Leverage," CEPR Discussion Papers 11681, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11681
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    References listed on IDEAS

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    1. Peter J. Wallison, 2011. "Dissent from the Majority Report of the Financial Crisis Inquiry Commission," Books, American Enterprise Institute, number 50848, September.
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    8. 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.
    9. Cochrane, John H, 1991. "A Simple Test of Consumption Insurance," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 957-976, October.
    10. 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.
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    Cited by:

    1. Racicot, François-Éric & Théoret, Raymond, 2018. "Multi-moment risk, hedging strategies, & the business cycle," International Review of Economics & Finance, Elsevier, vol. 58(C), pages 637-675.

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