IDEAS home Printed from https://ideas.repec.org/p/fmg/fmgdps/dp707.html
   My bibliography  Save this paper

Asset Pricing with Heterogeneous Investors and Portfolio Constraints

Author

Listed:
  • Georgy Chabakauri

Abstract

We study dynamic general equilibrium in one-tree and two-trees Lucas economies with one consumption good and two CRRA investors with heterogeneous risk aversions and portfolio constraints. We provide a tractable characterization of equilibrium without relying on the assumption of logarithmic constrained investors, popular in the literature, under which wealthconsumption ratios of these investors are unaffected by constraints. In one-tree economy we focus on the impact of limited stock market participation and margin constraints on market prices of risk, interest rates, stock return volatilities and price-dividend ratios. We demonstrate conditions under which constraints increase or decrease these equilibrium processes, and generate dynamic patterns consistent with empirical findings. In a two-trees economy we demonstrate that investor heterogeneity gives rise to large countercyclical excess stock return correlations, but margin constraints significantly reduce them by restricting the leverage in the economy, and give rise to rich saddle-type patterns. We also derive a new closed-form consumption CAPM that captures the impact of constraints on stock risk premia.

Suggested Citation

  • Georgy Chabakauri, 2012. "Asset Pricing with Heterogeneous Investors and Portfolio Constraints," FMG Discussion Papers dp707, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp707
    as

    Download full text from publisher

    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp707-PWC30.pdf
    Download Restriction: no
    ---><---

    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. 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.
    3. Bernard Dumas & Andrew Lyasoff, 2012. "Incomplete-Market Equilibria Solved Recursively on an Event Tree," Journal of Finance, American Finance Association, vol. 67(5), pages 1897-1941, October.
    4. 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.
    5. Guvenen, Fatih, 2006. "Reconciling conflicting evidence on the elasticity of intertemporal substitution: A macroeconomic perspective," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1451-1472, October.
    6. Jérôme B. Detemple & Ren Garcia & Marcel Rindisbacher, 2003. "A Monte Carlo Method for Optimal Portfolios," Journal of Finance, American Finance Association, vol. 58(1), pages 401-446, February.
    7. Hardouvelis, Gikas A & Pericli, Andreas & Theodossiou, Panayiotis, 1997. "The Asymmetric Relation Between Margin Requirements and Stock Market Volatility Across Bull and Bear Markets," CEPR Discussion Papers 1746, C.E.P.R. Discussion Papers.
    8. Basak, Suleyman & Croitoru, Benjamin, 2000. "Equilibrium Mispricing in a Capital Market with Portfolio Constraints," Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 715-748.
    9. Cvitanic, Jaksa & Malamud, Semyon, 2011. "Price impact and portfolio impact," Journal of Financial Economics, Elsevier, vol. 100(1), pages 201-225, April.
    10. Yili Chien & Harold Cole & Hanno Lustig, 2011. "A Multiplier Approach to Understanding the Macro Implications of Household Finance," Review of Economic Studies, Oxford University Press, vol. 78(1), pages 199-234.
    11. Harjoat S. Bhamra & Raman Uppal, 2014. "Asset Prices with Heterogeneity in Preferences and Beliefs," Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 519-580.
    12. Gromb, Denis & Vayanos, Dimitri, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 361-407.
    13. Denis Gromb & Dimitri Vayanos, 2010. "Limits of Arbitrage: The State of the Theory," NBER Working Papers 15821, National Bureau of Economic Research, Inc.
    14. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, December.
    15. Andrea Buraschi & Paolo Porchia & Fabio Trojani, 2010. "Correlation Risk and Optimal Portfolio Choice," Journal of Finance, American Finance Association, vol. 65(1), pages 393-420, February.
    16. Anna Pavlova & Roberto Rigobon, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," Review of Economic Studies, Oxford University Press, vol. 75(4), pages 1215-1256.
    17. 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.
    18. Jér^me Detemple & Marcel Rindisbacher, 2005. "Closed‐Form Solutions For Optimal Portfolio Selection With Stochastic Interest Rate And Investment Constraints," Mathematical Finance, Wiley Blackwell, vol. 15(4), pages 539-568, October.
    19. 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.
    20. 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.
    21. Coen-Pirani, Daniele, 2005. "Margin requirements and equilibrium asset prices," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 449-475, March.
    22. Nicolae Gârleanu & Lasse Heje Pedersen, 2011. "Margin-based Asset Pricing and Deviations from the Law of One Price," Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 1980-2022.
    23. Detemple, Jerome & Murthy, Shashidhar, 1997. "Equilibrium Asset Prices and No-Arbitrage with Portfolio Constraints," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 1133-1174.
    24. Harold L. Cole & Hanno & YiLi Chien, 2007. "Macro Implications of Household Finance," 2007 Meeting Papers 479, Society for Economic Dynamics.
    25. Harjoat S. Bhamra & Raman Uppal, 2009. "The Effect of Introducing a Non-Redundant Derivative on the Volatility of Stock-Market Returns When Agents Differ in Risk Aversion," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2303-2330, June.
    26. Hugonnier, Julien, 2012. "Rational asset pricing bubbles and portfolio constraints," Journal of Economic Theory, Elsevier, vol. 147(6), pages 2260-2302.
    27. Srinivas, P.S. & Whitehouse, Edward & Yermo, Juan, 2000. "Regulating private pension funds'structure, performance, and investments : cross-country evidence," Social Protection Discussion Papers and Notes 23302, The World Bank.
    28. Fatih Guvenen, 2009. "A Parsimonious Macroeconomic Model for Asset Pricing," Econometrica, Econometric Society, vol. 77(6), pages 1711-1750, November.
    29. Paul Ehling & Christian Heyerdahl-Larsen, 2017. "Correlations," Management Science, INFORMS, vol. 63(6), pages 1919-1937, June.
    30. Ian Martin, 2013. "The Lucas Orchard," Econometrica, Econometric Society, vol. 81(1), pages 55-111, January.
    31. Basak, Suleyman, 2000. "A model of dynamic equilibrium asset pricing with heterogeneous beliefs and extraneous risk," Journal of Economic Dynamics and Control, Elsevier, vol. 24(1), pages 63-95, January.
    32. Stavros Panageas, 2020. "The Implications of Heterogeneity and Inequality for Asset Pricing," NBER Working Papers 26974, National Bureau of Economic Research, Inc.
    33. Joost Driessen & Pascal J. Maenhout & Grigory Vilkov, 2009. "The Price of Correlation Risk: Evidence from Equity Options," Journal of Finance, American Finance Association, vol. 64(3), pages 1377-1406, June.
    34. G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003. "Handbook of the Economics of Finance," Handbook of the Economics of Finance, Elsevier, edition 1, volume 1, number 1.
    35. Basak, Suleyman, 2005. "Asset pricing with heterogeneous beliefs," Journal of Banking & Finance, Elsevier, vol. 29(11), pages 2849-2881, November.
    36. Alexander Shapiro, 2002. "The Investor Recognition Hypothesis in a Dynamic General Equilibrium: Theory and Evidence," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 97-141, March.
    37. Michael Gallmeyer & Burton Hollifield, 2008. "An Examination of Heterogeneous Beliefs with a Short-Sale Constraint in a Dynamic Economy," Review of Finance, European Finance Association, vol. 12(2), pages 323-364.
    38. Basak, Suleyman & Croitoru, Benjamin, 2006. "On the role of arbitrageurs in rational markets," Journal of Financial Economics, Elsevier, vol. 81(1), pages 143-173, July.
    39. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
    40. Hui Chen & Scott Joslin, 2012. "Generalized Transform Analysis of Affine Processes and Applications in Finance," Review of Financial Studies, Society for Financial Studies, vol. 25(7), pages 2225-2256.
    41. 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.
    42. Gikas A. Hardouvelis & Panayiotis Theodossiou, 2002. "The Asymmetric Relation Between Initial Margin Requirements and Stock Market Volatility Across Bull and Bear Markets," Review of Financial Studies, Society for Financial Studies, vol. 15(5), pages 1525-1560.
    43. Francisco Gomes & Alexander Michaelides, 2008. "Asset Pricing with Limited Risk Sharing and Heterogeneous Agents," Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 415-448, January.
    44. 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.
    45. Jun Liu, 2007. "Portfolio Selection in Stochastic Environments," Review of Financial Studies, Society for Financial Studies, vol. 20(1), pages 1-39, January.
    46. G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003. "Handbook of the Economics of Finance," Handbook of the Economics of Finance, Elsevier, edition 1, volume 1, number 2.
    47. Cuoco, Domenico, 1997. "Optimal Consumption and Equilibrium Prices with Portfolio Constraints and Stochastic Income," Journal of Economic Theory, Elsevier, vol. 72(1), pages 33-73, January.
    48. Tano Santos & Pietro Veronesi, 2006. "Labor Income and Predictable Stock Returns," Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 1-44.
    49. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-455, July.
    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. Chabakauri, Georgy, 2010. "Asset pricing with heterogeneous investors and portfolio constraints," LSE Research Online Documents on Economics 43142, London School of Economics and Political Science, LSE Library.
    2. Georgy Chabakauri, 2012. "Asset Pricing with Heterogeneous Investors and Portfolio Constraints," 2012 Meeting Papers 636, Society for Economic Dynamics.
    3. Chabakauri, Georgy, 2015. "Asset pricing with heterogeneous preferences, beliefs, and portfolio constraints," Journal of Monetary Economics, Elsevier, vol. 75(C), pages 21-34.
    4. Chabakauri, Georgy & Rytchkov, Oleg, 2021. "Asset pricing with index investing," Journal of Financial Economics, Elsevier, vol. 141(1), pages 195-216.
    5. Chabakauri, Georgy, 2015. "Dynamic equilibrium with rare events and heterogeneous Epstein-Zin investors," LSE Research Online Documents on Economics 60737, London School of Economics and Political Science, LSE Library.
    6. Tran, Ngoc-Khanh & Zeckhauser, Richard J., 2011. "The Behavior of Savings and Asset Prices When Preferences and Beliefs Are Heterogeneous," Working Paper Series rwp11-026, Harvard University, John F. Kennedy School of Government.
    7. Chabakauri, Georgy, 2015. "Dynamic equilibrium with rare events and heterogeneous epstein-zin investors," LSE Research Online Documents on Economics 62003, London School of Economics and Political Science, LSE Library.
    8. Stavros Panageas, 2020. "The Implications of Heterogeneity and Inequality for Asset Pricing," NBER Working Papers 26974, National Bureau of Economic Research, Inc.
    9. Chabakauri, Georgy & Han, Brandon Yueyang, 2020. "Collateral constraints and asset prices," Journal of Financial Economics, Elsevier, vol. 138(3), pages 754-776.
    10. Tyler Abbot, 2017. "General Equilibrium Under Convex Portfolio Constraints and Heterogeneous Risk Preferences," Papers 1706.05877, arXiv.org, revised Jun 2018.
    11. Christian Heyerdahl-Larsen & Philipp Illeditsch, 2018. "Demand Disagreement," 2018 Meeting Papers 607, Society for Economic Dynamics.
    12. Hugonnier, Julien, 2012. "Rational asset pricing bubbles and portfolio constraints," Journal of Economic Theory, Elsevier, vol. 147(6), pages 2260-2302.
    13. Chabakauri, Georgy & Rytchkov, Oleg, 2014. "Asset pricing with index investing," LSE Research Online Documents on Economics 60739, London School of Economics and Political Science, LSE Library.
    14. Hansen, Simon Lysbjerg, 2015. "Cross-sectional asset pricing with heterogeneous preferences and beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 125-151.
    15. Harjoat S. Bhamra & Raman Uppal, 2014. "Asset Prices with Heterogeneity in Preferences and Beliefs," Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 519-580.
    16. Kargar, Mahyar, 2021. "Heterogeneous intermediary asset pricing," Journal of Financial Economics, Elsevier, vol. 141(2), pages 505-532.
    17. John Donaldson & Rajnish Mehra, 2007. "Risk Based Explanations of the Equity Premium," NBER Working Papers 13220, National Bureau of Economic Research, Inc.
    18. Jean-Pierre Zigrand & Hyun Song Shin & Jon Danielsson, 2010. "Risk Appetite and Endogenous Risk," FMG Discussion Papers dp647, Financial Markets Group.
    19. Buss, Adrian & Uppal, Raman & Vilkov, Grigory, 2015. "Asset prices in general equilibrium with recursive utility and illiquidity induced by transactions costs," SAFE Working Paper Series 41, Leibniz Institute for Financial Research SAFE.
    20. Edmond, Chris & Weill, Pierre-Olivier, 2012. "Aggregate implications of micro asset market segmentation," Journal of Monetary Economics, Elsevier, vol. 59(4), pages 319-335.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    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:fmg:fmgdps:dp707. 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: . General contact details of provider: http://www.lse.ac.uk/fmg/ .

    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 bibliographic 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.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: The FMG Administration (email available below). General contact details of provider: http://www.lse.ac.uk/fmg/ .

    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.