Asset Pricing with Heterogeneous Consumers

Abstract

Empirical difficulties encountered by representative-consumer models are resolved in an economy with heterogeneity in the form of uninsurable, persistent, and heteroscedastic labor income shocks. Given the joint process of arbitrage-free asset prices, dividends, and aggregate income, satisfying a certain joint restriction, it is shown that this process is supported in the equilibrium of an economy with judiciously modeled income heterogeneity. The Euler equations of consumption in a representative-agent economy are replaced by a set of Euler equations that depend not only on the per capita consumption growth but also on the cross-sectional variance of the individual consumers' consumption growth. Constantinides acknowledges support from a gift to the Graduate School of Business, University of Chicago, by Dimensional Fund Advisors. Duffie acknowledges support from the National Science Foundation under grant SES 90-10062 and from Deutsche Forschungsgemeinschaft, Sonderforschungsbereich 303 as well as the Gottfried-Wilhelm-Leibniz-Forderpreis. We are grateful for comments from John Cochrane,

Asset returns in an endogenous growth model with incomplete markets

“…3 In this paper, we show that there exists an equilibrium in which households optimally choose not to use bond trading (borrowing and lending) to smooth out idiosyncratic income shocks. 4 This no-trade result extends the work by Constantinides and Duffie (1996) to production economies with not necessarily normally distributed random variables. 5 As in Constantinides and Duffie (1996), the idiosyncratic component of log-income follows (approximately) a random walk, and borrowing and lending is therefore a highly ineffective means to insulate consumption from income shocks.…”

“…7 Our second finding is that the presence of uninsurable idiosyncratic income risk substantially increases the mean equity premium. In our model, as in the work by Constantinides and Duffie (1996) and Storesletten, Telmer, and Yaron (2001), this result is driven by two features of the income process: idiosyncratic income shocks are permanent and the amount of idiosyncratic risk is increasing during economic downturns. Recent empirical work has shown (Meghir andPistaferri, 2001, andStoresletten et al, 2001) that individual income data are well-described by an income process that exhibits a large and counter-cyclical permanent component, and we use the estimates of this empirical literature to calibrate the model economy.…”

“…In contrast to Constantinides and Duffie (1996), in this paper the random walk property of logincome is an endogenous outcome, and not all income is consumed (aggregate saving is positive).…”

“…As in Constantinides and Duffie (1996), in equilibrium the future consumption and income growth rates will be identically distributed across households conditional on .…”

Nonmyopic Optimal Portfolios in Viable Markets

“…38 This is indirectly related to the state price density inequality of Constantinides and Duffie (1996).…”