Dynamic General Equilibrium and T-Period Fund Separation
We consider a dynamic general equilibrium model with incomplete markets in which we derive conditions for separating the savings decision from the asset allocation decision. It is shown that with logarithmic utility functions this separation holds for any heterogeneity of discount factors while the generalization to constant relative risk aversion only holds for homogeneous discount factors. Our results have simple asset pricing implications for the time series and also the cross section of asset prices. It is found that on data from the DJIA a risk aversion weaker than in the logarithmic case fits best.
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