Asset price volatility is an enduring feature of financial time series and a striking anomaly for dynamic general equilibrium models of asset pricing with homogeneous consumers. Campbell (2002), for instance, finds that diversified stock portfolios undergo large movements in returns relative to observed changes in the growth rates of dividends and aggregate consumption.
The puzzling nature of the co–movement between aggregate consumption growth and the price–dividend ratio has led researchers to non–standard assumptions about the representative household’s utility function like strong habit persistence, as in Constantinides (1990) and Campbell and Cochrane (1999) and other forms of extremely poor substitutability of consumption at different date–state events.
Using standard assumptions on preferences, this paper analyzes a class of pure exchange economies, with heterogeneous households and no commitment to intertemporal trades, in which the price of a productive asset fluctuates even though the structure of the economy remains unchanged. This class of economies is the two–state–of–nature counterpart of settings studied in Alvarez and Jermann (2000) and Kehoe and Levine (2001), but with substantially more heterogeneity added. To simplify matters, we abstract completely from aggregate shocks, except for a numerical example at the end of Section 6. We focus instead on environments with correlated individual incomes, constant dividends and constant aggregate income.
These environments may be interpreted as suffering from asymmetric sectoral shocks which take income away from a few sectors or households and redistribute it to all other sectors or households. As in earlier literature, we assume that consumers cannot credibly commit to deliver future consumption but are dissuaded from actual default by a central credit agency which seizes the assets of defaulters and keeps their names on a black list which denies them credit for a fixed term of L ? 0 periods. The threat of market exclusion is sufficient to prevent everyone from borrowing more than they would be willing to repay given the length of exclusion from intertemporal trading. Longer exclusion lengths strengthen the self–enforcing nature of intertemporal trades, and typically produce outcomes with smaller fluctuations and better welfare properties.
Heterogeneity among consumers leads to a natural pattern of market segmentation. Impatient agents with relatively stable incomes and intertemporally substitutable consumption are not allowed to borrow at all and stay out of asset markets forever. All other agents are recurrently rationed, with the possible exception of the most patient consumers.
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