The Market Price of Aggregate Risk and the Wealth Distribution

Topics:
Commercial Banking,
Insurance,
Investment and Capital Markets
Tags:
Bankruptcy,
Business Operations,
Litigation,
Management,
Market Price,
National Bureau Of Economic Research,
Strategy
Source:
National Bureau of Economic Research

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Overview: This paper introduces bankruptcy into a complete markets model with a continuum of ex ante identical agents who have power utility. The model yields a large equity premium, a low risk-free rate and a time-varying market price of risk for reasonable risk aversion. Bankruptcy gives rise to a second risk factor in addition to aggregate consumption growth risk. This liquidity risk is created by binding solvency constraints. The risk is measured by one moment of the wealth distribution, which multiplies the standard Breeden-Lucas stochastic discount factor. This captures the aggregate shadow cost of the solvency constraints.

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Format: PDF | Size: 499KB | Date: Feb 2005 | Pages: 59

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