A Multiplier Approach to Understanding the Macro Implications of Household Finance

Abstract

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 models with heterogeneous agents, our model matches the high volatility of returns and the low volatility of the risk-free rate.

The risk premium and long-run global imbalances

“…The second friction, which is limited participation combined with a relatively small fraction of Mertonian traders, produces a high equity premium by concentrating the aggregate risk among Mertonian traders. This is in line with Chien et al (2011), who use a similar setup in a closed economy to explain the average level and volatility of risk premiums.…”

Home Bias in Open Economy Financial Macroeconomics

“…Developing global methods would be useful as they would potentially be adequate in environments where standard perturbation methods fail and they could also provide insights on the accuracy of perturbation methods. Recent work in that direction includes Dumas and Lyasoff (2011) in finitehorizons models and Chien, Cole, and Lustig (2011) in a one-good closed economy model with multiple agents. Extending these methods to standard international macro models is a next important step.…”

Dynamic Equilibrium with Two Stocks, Heterogeneous Investors, and Portfolio Constraints

“…First, we use the fixed point iteration method that has been widely used in the economic literature in various settings [e.g., Gomes and Michaelides (2008); Guvenen (2009); Chien, Cole, and Lustig (2011)]. This method at step k evaluates all coefficients of PDEs (24)-(25) using the solution from the previous step k − 1.…”