Article2001

Quantitative Asset Pricing Implications of Endogenous Solvency Constraints

195 citations0/0 files storedReview of Financial Studies

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Economic theories and models Financial Markets and Investment Strategies Stochastic processes and financial applications

Abstract

We study the asset pricing implications of an economy where solvency constraints are endogenously determined to deter agents from defaulting while allowing as much risk sharing as possible. We solve analytically for efficient allocations and for the corresponding asset prices, portfolio holdings, and solvency constraints for a simple example. Then we calibrate a more general model to U.S. aggregate as well as idiosyncratic income processes. We find equity premia, risk premia for long-term bonds, and Sharpe ratios of magnitudes similar to the U.S. data for lowrisk aversion and a low time-discount factor.

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References

1985The equity premium: A puzzle 1988On the Theory of Infinitely Repeated Games with Discounting 1990Toward a Theory of Discounted Repeated Games with Imperfect Monitoring 1996Asset Pricing with Heterogeneous Consumers 1991A Simple Test of Consumption Insurance 2000Efficiency, Equilibrium, and Asset Pricing with Risk of Default 1996Implications of Efficient Risk Sharing without Commitment 1991Full Insurance in the Presence of Aggregate Uncertainty

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