"Overreaction" of Asset Prices in General Equilibrium / S. Rao Aiyagari, Mark Gertler.

Format:

Book

Author/Creator:

Aiyagari, S. Rao.

Contributor:

National Bureau of Economic Research.

Gertler, Mark.

Series:

Working Paper Series (National Bureau of Economic Research) no. w6747.

NBER working paper series no. w6747

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1998.

Summary:

We attempt to explain the overreaction of asset prices to movements in short-term interest rates, dividends, and asset supplies. The key element of our explanation is a margin constraint that traders face which limits their leverage to a fraction of the value of their assets. Traders may lever themselves further, either directly by borrowing short term or indirectly by engaging in futures and options trading, so that the scenario is relevant to contemporary financial markets. When some shock pushes asset prices to a low enough level at which the margin constraint binds, traders are forced to liquidate assets. This drives asset prices below what they would be with frictionless markets. Also, a shock which simply increases the likelihood that the margin constraint will bind can have a very similar effect on asset prices. We construct a general equilibrium model with margin constrained traders and derive some qualitative properties of asset prices. We present an analytical solution for a deterministic version of the model and a simple numerical computation of the stochastic version.

Notes:

Print version record

October 1998.