IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

The Market Price of Aggregate Risk and the Wealth Distribution

  • Hanno Lustig

    (Dept. of Economics Stanford University)

Bankruptcy brings the asset pricing implications of Lucas's (1978) endowment economy in line with the data. I introduce bankruptcy into a complete markets model with a continuum of ex ante identical agents who have CRRA utility. Shares in a Lucas tree serve as collateral. The model yields a large equity premium, a low risk-free rate and a time-varying market price of risk for reasonable risk aversion gamma. Bankruptcy gives rise to a second risk factor in addition to aggregate consumption growth risk. This liquidity risk is created by binding solvency constraints. The risk is measured by the growth rate of a particular moment of the Pareto-Negishi weight distribution, which multiplies the standard Breeden-Lucas stochastic discount factor. The economy is said to experience a negative liquidity shock when this growth rate is high and a large fraction of agents faces severely binding solvency constraints. These shocks occur in recessions. The average investor wants a high excess return on stocks to compensate for the extra liquidity risk, because of low stock returns in recessions. In that sense stocks are ``bad collateral''. The adjustment to the Breeden-Lucas stochastic discount factor raises the unconditional risk premium and induces time variation in conditional risk premia. This explains why stock returns are highly predictable over longer holding periods.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://econwpa.repec.org/eps/fin/papers/0111/0111004.pdf
Download Restriction: no

Paper provided by EconWPA in its series Finance with number 0111004.

as
in new window

Length: 71 pages
Date of creation: 16 Nov 2001
Date of revision: 16 Nov 2001
Handle: RePEc:wpa:wuwpfi:0111004
Note: Type of Document - pdf; prepared on IBM PC ; to print on HP/PostScript/Franciscan monk; pages: 71; figures: figures in document
Contact details of provider: Web page: http://econwpa.repec.org

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Alon Brav & George M. Constantinides & Christopher C. Geczy, 2002. "Asset Pricing with Heterogeneous Consumers and Limited Participation: Empirical Evidence," NBER Working Papers 8822, National Bureau of Economic Research, Inc.
  2. Lucas, Deborah J., 1994. "Asset pricing with undiversifiable income risk and short sales constraints: Deepening the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 325-341, December.
  3. Albert Marcet & Ramon Marimon, 1994. "Recursive contracts," Economics Working Papers 337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.
  4. S. Rao Aiyagari & Mark Gertler, 1990. "Asset Returns with Transactions Cost and Uninsured Risk: A Stage III Exercise," NBER Working Papers 3481, National Bureau of Economic Research, Inc.
  5. Patrick J. Kehoe & Fabrizio Perri, 2000. "International Business Cycles with Endogenous Incomplete Markets," NBER Working Papers 7870, National Bureau of Economic Research, Inc.
  6. Phelan, Christopher & Townsend, Robert M, 1991. "Computing Multi-period, Information-Constrained Optima," Review of Economic Studies, Wiley Blackwell, vol. 58(5), pages 853-81, October.
  7. Tobias J. Moskowitz & Annette Vissing-Jørgensen, 2002. "The Returns to Entrepreneurial Investment: A Private Equity Premium Puzzle?," American Economic Review, American Economic Association, vol. 92(4), pages 745-778, September.
  8. Tobias J. Moskowitz & Annette Vissing-Jorgensen, 2002. "The Returns to Entrepreneurial Investment: A Private Equity Premium Puzzle?," NBER Working Papers 8876, National Bureau of Economic Research, Inc.
  9. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
  10. Fernando Alvarez & Urban J. Jermann, 1999. "Quantitative Asset Pricing Implications of Endogenous Solvency Constraints," NBER Working Papers 6953, National Bureau of Economic Research, Inc.
  11. Martin Browning & Lars Peter Hansen & James J. Heckman, 1999. "Micro Data and General Equilibrium Models," Discussion Papers 99-10, University of Copenhagen. Department of Economics.
  12. Lettau, Martin, 1998. "Idiosyncratic Risk and Volatility Bounds, or, Can Models with Idiosyncratic Risk Solve the Equity Premium Puzzle?," CEPR Discussion Papers 1795, C.E.P.R. Discussion Papers.
  13. John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
  14. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
  15. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 225-62, April.
  16. Kehoe, Timothy J. & Levine, David K. & Prescott, Edward C., 2002. "Lotteries, Sunspots, and Incentive Constraints," Journal of Economic Theory, Elsevier, vol. 107(1), pages 39-69, November.
  17. He, Hua & Modest, David M, 1995. "Market Frictions and Consumption-Based Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 94-117, February.
  18. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
  19. Lars Hansen & Thomas Sargent & Thomas Tallarini, . "Robust Permanent Income and Pricing," GSIA Working Papers 1997-51, Carnegie Mellon University, Tepper School of Business.
  20. Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-27, May.
  21. Fernando Alvarez & Urban J. Jermann, 2000. "Using Asset Prices to Measure the Cost of Business Cycles," NBER Working Papers 7978, National Bureau of Economic Research, Inc.
  22. Felix Kubler & Karl Schmedders, 2003. "Stationary Equilibria in Asset-Pricing Models with Incomplete Markets and Collateral," Econometrica, Econometric Society, vol. 71(6), pages 1767-1793, November.
  23. S Rao Aiyagari & Mark Gertler, 1997. "Asset Returns with transaction costs and uninsured individual risk," Levine's Working Paper Archive 648, David K. Levine.
  24. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
  25. Peter Hammond & Yeneng Sun, 2001. "Monte Carlo Simulation of Macroeconomic Risk with a Continuum of Agents: The Symmetric Case," Working Papers 01015, Stanford University, Department of Economics.
  26. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  27. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
  28. Narayana R. Kocherlakota & Luigi Pistaferri, 2004. "Asset Pricing Implications of Pareto Optimality with Private Information," Levine's Bibliography 122247000000000508, UCLA Department of Economics.
  29. John H. Cochrane & Lars Peter Hansen, 1992. "Asset Pricing Explorations for Macroeconomics," NBER Chapters, in: NBER Macroeconomics Annual 1992, Volume 7, pages 115-182 National Bureau of Economic Research, Inc.
  30. Pradeep Dubey & John Geanakoplos & Martin Shubik, 1988. "Default and Efficiency in a General Equilibrium Model with Incomplete Markets," Cowles Foundation Discussion Papers 879R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1989.
  31. Cogley, Timothy, 2002. "Idiosyncratic risk and the equity premium: evidence from the consumer expenditure survey," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 309-334, March.
  32. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
  33. Abreu, Dilip & Pearce, David & Stacchetti, Ennio, 1986. "Optimal cartel equilibria with imperfect monitoring," Journal of Economic Theory, Elsevier, vol. 39(1), pages 251-269, June.
  34. John Heaton & Deborah Lucas, 2000. "Portfolio Choice and Asset Prices: The Importance of Entrepreneurial Risk," Journal of Finance, American Finance Association, vol. 55(3), pages 1163-1198, 06.
  35. 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.
  36. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January.
  37. Marcet, Albert & Singleton, Kenneth J., 1999. "Equilibrium Asset Prices And Savings Of Heterogeneous Agents In The Presence Of Incomplete Markets And Portfolio Constraints," Macroeconomic Dynamics, Cambridge University Press, vol. 3(02), pages 243-277, June.
  38. Whitelaw, Robert F, 1994. " Time Variations and Covariations in the Expectation and Volatility of Stock Market Returns," Journal of Finance, American Finance Association, vol. 49(2), pages 515-41, June.
  39. Ethan Ligon & Jonathan P Thomas & Tim Worrall, 1997. "Informal Insurance Arrangements in Village Economies," CRIEFF Discussion Papers 9705, Centre for Research into Industry, Enterprise, Finance and the Firm.
  40. Grossman, Sanford J. & Shiller, Robert J., 1982. "Consumption correlatedness and risk measurement in economies with non-traded assets and heterogeneous information," Journal of Financial Economics, Elsevier, vol. 10(2), pages 195-210, July.
  41. Fernando Alvarez & Urban J. Jermann, 2001. "The Size of the Permanent Component of Asset Pricing Kernels," NBER Working Papers 8360, National Bureau of Economic Research, Inc.
  42. He, Hua & Pearson, Neil D., 1991. "Consumption and portfolio policies with incomplete markets and short-sale constraints: The infinite dimensional case," Journal of Economic Theory, Elsevier, vol. 54(2), pages 259-304, August.
  43. Orazio Attanasio & Steven J. Davis, 1994. "Relative Wage Movements and the Distribution of Consumption," NBER Working Papers 4771, National Bureau of Economic Research, Inc.
  44. repec:cup:macdyn:v:3:y:1999:i:2:p:243-77 is not listed on IDEAS
  45. Kjetil Storesletten & Chris Telmer & Amir Yaron, . "Persistent Idiosyncratic Shocks and Incomplete Markets," GSIA Working Papers 24, Carnegie Mellon University, Tepper School of Business.
  46. Kjetil Storesletten & Chris I. Telmer & Amir Yaron, 2004. "Cyclical Dynamics in Idiosyncratic Labor Market Risk," Journal of Political Economy, University of Chicago Press, vol. 112(3), pages 695-717, June.
  47. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers 445, Federal Reserve Bank of Minneapolis.
  48. Zhang, H.H., 1995. "Endogenous Borrowing Constraints with Incomplete Markets," GSIA Working Papers 1995-25, Carnegie Mellon University, Tepper School of Business.
  49. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  50. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 1-53, February.
  51. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  52. Robert M. Townsend, 1995. "Consumption Insurance: An Evaluation of Risk-Bearing Systems in Low-Income Economies," Journal of Economic Perspectives, American Economic Association, vol. 9(3), pages 83-102, Summer.
  53. N. Gregory Mankiw, 1986. "The Equity Premium and the Concentration of Aggregate Shocks," NBER Working Papers 1788, National Bureau of Economic Research, Inc.
  54. Atkeson Andrew & Lucas Jr. , Robert E., 1995. "Efficiency and Equality in a Simple Model of Efficient Unemployment Insurance," Journal of Economic Theory, Elsevier, vol. 66(1), pages 64-88, June.
  55. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
  56. 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.
  57. Lettau, Martin & Ludvigson, Sydney, 1999. "Consumption, Aggregate Wealth and Expected Stock Returns," CEPR Discussion Papers 2223, C.E.P.R. Discussion Papers.
  58. John Y. Campbell, 2000. "Asset Pricing at the Millennium," NBER Working Papers 7589, National Bureau of Economic Research, Inc.
  59. Luttmer, Erzo G J, 1996. "Asset Pricing in Economies with Frictions," Econometrica, Econometric Society, vol. 64(6), pages 1439-67, November.
  60. Atkeson, Andrew & Lucas, Robert E, Jr, 1992. "On Efficient Distribution with Private Information," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 427-53, July.
  61. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
  62. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
  63. Constantinides, George M, 1982. "Intertemporal Asset Pricing with Heterogeneous Consumers and without Demand Aggregation," The Journal of Business, University of Chicago Press, vol. 55(2), pages 253-67, April.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpfi:0111004. 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: (EconWPA)

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 references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.