Pricing Two Trees When Mildew Infests the Orchard: How Does Contagion Affect General Equilibrium Asset Prices?

We endogenize asset liquidity and financing constraints in a dynamic general equilibrium model with search frictions on capital markets. Assets traded on frictional capital markets are only partially saleable. Liquid assets, such as fiat money, instead, are not subject to search frictions and can be used to insure idiosyncratic investment risks. Partially saleable assets thus carry a liquidity premium over fully liquid assets. We show that, in equilibrium, low asset saleability is typically associated with lower asset prices, tighter financing constraints, thus stronger demand for public liquidity. Lower asset liquidity feeds into real allocations, constraining real investment, consumption, and production.

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Dynamic General Equilibrium and T-Period Fund Separation

Journal of Financial and Quantitative Analysis ◽

10.1017/s0022109010000049 ◽

2010 ◽

Vol 45 (2) ◽

pp. 369-400 ◽

Cited By ~ 2

Author(s):

Anke Gerber ◽

Thorsten Hens ◽

Peter Woehrmann

Keyword(s):

Asset Pricing ◽

Risk Aversion ◽

General Equilibrium ◽

Asset Allocation ◽

Mutual Fund ◽

Asset Prices ◽

Dynamic General Equilibrium ◽

Discount Factors ◽

Equilibrium Asset Pricing ◽

Mutual Fund Separation

AbstractIn a dynamic general equilibrium model, we derive conditions for a mutual fund separation property by which the savings decision is separated from the asset allocation decision. With logarithmic utility functions, this separation holds for any heterogeneity in discount factors, while the generalization to constant relative risk aversion holds only for homogeneous discount factors but allows for any heterogeneity in endowments. The logarithmic case provides a general equilibrium foundation for the growth-optimal portfolio literature. Both cases yield equilibrium asset pricing formulas that allow for investor heterogeneity, in which the return process is endogenous and asset prices are determined by expected discounted relative dividends. Our results have simple asset pricing implications for the time series as well as the cross section of relative asset prices. It is found that on data from the Dow Jones Industrial Average, a risk aversion smaller than in the logarithmic case fits best.

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