Journal Article

A Multiplier Approach to Understanding the Macro Implications of Household Finance

Yili Chien, Harold Cole and Hanno Lustig

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 78, issue 1, pages 199-234
Published in print January 2011 | ISSN: 0034-6527
Published online January 2011 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1093/restud/rdq008
A Multiplier Approach to Understanding the Macro Implications of Household Finance

Show Summary Details

Preview

Our paper examines the impact of heterogeneous trading technologies for households on asset prices and the distribution of wealth. We distinguish between passive traders who hold fixed portfolios of stocks and bonds, and active traders who adjust their portfolios to changes in expected returns. To solve the model, we derive an optimal consumption sharing rule that does not depend on the trading technology, and we derive an aggregation result for state prices. This allows us to solve for equilibrium prices and allocations without having to search for market clearing prices in each asset market separately. We show that the fraction of total wealth held by active traders, not the fraction held by all participants, is critical for asset prices because only these traders respond to variation in state prices and hence absorb the residual aggregate risk created by non-participants. We calibrate the heterogeneity in trading technologies to match the equity premium and the risk-free rate. The calibrated model reproduces the skewness and kurtosis of the wealth distribution in the data. In contrast to existing asset pricing models with heterogeneous agents, our model matches the high volatility of returns and the low volatility of the risk-free rate.

Keywords: Asset pricing; Household finance; Risk sharing; Limited participation; G12

Journal Article.  14943 words.  Illustrated.

Subjects: Economics

Full text: subscription required

How to subscribe Recommend to my Librarian

Users without a subscription are not able to see the full content. Please, subscribe or login to access all content.