The market price of aggregate risk and the wealth distribution
By: Hanno Lustig.
Contributors: National Bureau of Economic Research.
Series: NBER working paper series ;; working paper 11132; Working paper series (National Bureau of Economic Research : Online) ;; working paper no. 11132.
Publisher: National Bureau of Economic Research
Published: 2005
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Subjects: Risk -- Mathematical models.; Bankruptcy -- Mathematical models.; Capital assets pricing model.; Wealth.
Description: "I introduce bankruptcy into a complete markets model with a continuum of ex ante identical agents who have power 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.  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 one moment of the wealth distribution, which multiplies the standard Breeden-Lucas stochastic discount factor.  This captures the aggregate shadow cost of the solvency constraints.  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"--National Bureau of Economic Research web site.
Notes: Also available in print.
Includes bibliographical references.
Title from PDF file as viewed on 2/25/2005.
System requirements: Adobe Acrobat Reader.
Mode of access: World Wide Web.