The Behavior of Savings and Asset Prices When Preferences and Beliefs are Heterogeneous / Ngoc-Khanh Tran, Richard J. Zeckhauser.

Format:

Book

Author/Creator:

Tran, Ngoc-Khanh.

Contributor:

National Bureau of Economic Research.

Zeckhauser, Richard J.

Series:

Working Paper Series (National Bureau of Economic Research) no. w17199.

NBER working paper series no. w17199

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2011.

Summary:

Movements in asset prices are a major risk confronting individuals. This paper establishes new asset pricing results when agents differ in risk preference, time preference and/or expectations. It shows that risk tolerance is a critical concept driving savings decisions, consumption allocations, prices and return volatilities. Surprisingly, due to the equilibrium risk sharing, the precautionary savings motive in the aggregate can vastly exceed that of even the most prudent actual agent in the economy. Consequently, a low real interest rate, resulting from large aggregate savings, can prevail with reasonable risk aversions for all agents. One downside of a large aggregate savings motive is that savings rates become extremely sensitive to output fluctuation. Thus, the same mechanism that produces realistically low interest rates tends to make them unrealistically volatile.

A powerful isomorphism allows differences in time preference and expectations to be swept away in the analysis, yielding an equivalent economy whose agents differ merely in risk aversion. These results hold great potential to simplify the analysis of heterogeneous-agent economies, as we demonstrate in quantifying how asset prices move and bounding their volatilities. All results are obtained in closed form for any number of agents possessing additively separable preferences in an endowment economy.

Notes:

Print version record

July 2011.