Investor Heterogeneity, Asset Pricing and Volatility Dynamics

Download or read book Investor Heterogeneity, Asset Pricing and Volatility Dynamics written by David Weinbaum and published by . This book was released on 2009 with total page 34 pages. Available in PDF, EPUB and Kindle. Book excerpt: We provide an explicit characterization of the equilibrium when investors have heterogeneous risk preferences. Given market completeness, investors can achieve full risk sharing. Thus a representative agent can be constructed, though this agent's risk aversion changes over time as the relative wealths of the individual investors change. We show that volatility depends on the covariance of aggregate risk aversion and stock returns. We find that heterogeneity increases volatility, produces volatility clustering (ARCH effects) and quot;leveragequot;-like effects. Option prices exhibit implied volatility skews. There is predictability and we assess the magnitude of investors' hedging demands and trading volume. Further, diversity is beneficial to all agents and entails welfare gains that can be substantial.