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Title: Catching up with the Joneses : heterogeneous preferences and the dynamics of asset prices
Authors: Chan, Yeung Lewis
Kogan, Leonid
Keywords: Heterogeneous preferences
Habit dependence
Asset pricing
Issue Date: 19-Dec-2000
Citation: Journal of political economy, v. 110, no. 6, Dec. 2002, p. 1255-1285
Abstract: We examine how cross-sectional heterogeneity in preferences affects equilibrium behavior of asset prices. We obtain explicit characterization of the competitive equilibrium in an exchange economy in which individual agents have catching up with the Joneses preferences and differ only with respect to the curvature of their utility functions. We show that heterogeneity can have a drastic effect on the behavior of asset prices, in particular, on their conditional moments. Dynamic re-distribution of wealth among the agents in heterogeneous economies leads to time-variation in aggregate risk aversion and market price of risk, generating empirically observed negative relation between conditional return volatility and expected returns on one hand and the level of stock prices on the other hand. This stands in contrast with the behavior of homogeneous economies with the same preferences, in which such relation is positive. Quantitatively, the heterogeneous model is capable of replicating various empirical properties of asset prices.
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