Working Paper: CEPR ID: DP9459
Authors: Harjoat S. Bhamra; Raman Uppal
Abstract: In this paper, we study asset prices in a dynamic, continuous-time, general-equilibrium endowment economy where agents have ?catching up with the Joneses? utility functions and differ with respect to their beliefs (because of differences in priors) and their preference parameters for time discount, risk aversion, and sensitivity to habit. A key contribution of our paper is to demonstrate how one can obtain a closed-form solution to the consumption-sharing rule for agents who have both heterogeneous priors and heterogeneous preferences without restricting the risk aversion of the two agents to special values. We solve in closed form also for the the state-price density, the riskless interest rate and market price of risk; the stock price, equity risk premium, and volatility of stock returns; the term structure of interest rates; and the conditions necessary to obtain a stationary equilibrium in which both agents survive in the long run. The methodology we develop is sufficiently general that, as long as markets are complete, it can be used to obtain the sharing rule and state prices for models set in discrete or continuous time and for arbitrary endowment and belief updating processes.
Keywords: Asset Pricing; General Equilibrium
JEL Codes: G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| heterogeneous beliefs and preferences (D80) | consumption-sharing rule (D16) |
| heterogeneous beliefs and preferences (D80) | equilibrium state price density (D59) |
| equilibrium state price density (D59) | asset pricing (G19) |
| heterogeneity in risk aversion and beliefs (D81) | volatility of asset returns (G17) |
| risk aversion (D81) | willingness to pay for consumption (D11) |
| habit formation (I12) | risk-free rate (G12) |
| habit formation (I12) | aggregate risk aversion (D81) |
| aggregate risk aversion (D81) | countercyclical behavior (E32) |