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Manchester Grand Hyatt, Regatta C
Heterogeneous Beliefs and Asset Pricing
Saturday, Jan. 4, 2020 8:00 AM - 10:00 AM (PDT)
- Chair: Efstathios Avdis, University of Alberta
The Macroeconomic Implications of Limited Arbitrage
AbstractWe develop a tractable model to study the macroeconomic impacts of limited arbitrage by linking arbitrage activities with the macroeconomy through collateralization. We show that the interactions between speculative trading and the business cycle can work as a powerful transmission mechanism, where trivial shocks spread, amplify, and trigger simultaneous arbitrage failures and recessions. Collateralization adds extra value to real-sector investments, and ultimately helps boost aggregate production. We solve for the model dynamics analytically and characterize multiple equilibria. Through regime shifts, we account for the non-linear aspects of financial crises as well as the slow and incomplete post-crisis recoveries.
Extrapolative Asset Pricing
AbstractWe study the asset pricing implications of stock return extrapolation by replacing rational expectations with an extrapolative expectation in an otherwise standard Lucas economy. We solve for the equilibrium in closed form. We find that extrapolation generates large deviations in the short rate and stock price from the rational counterparts. However, extrapolation actually exacerbates asset pricing puzzles: the short rate is volatile, the stock return has deficient volatility (lower volatility than the rational counterpart), and lower equity premium. Our results suggest that the extrapolation-based resolutions of these puzzles in recent studies are likely due to other features than extrapolation.
Costly Short Sales and Nonlinear Asset Pricing
AbstractWe study a dynamic general equilibrium model with costly-to-short stocks and heterogeneous beliefs. The model is solved in closed-form and shows that costly short sales drive a wedge between the valuation of assets that promise identical cash flows but are subject to different lending fees. The price of an asset is given by the risk-adjusted present value of its future cash flows, which include both dividends and an endogenous yield derived from lending fees. This pricing formula implies that asset returns satisfy a modified capital asset pricing model which includes a negative adjustment for lending fees and, thus, provides a theoretical foundation for the recent findings on the role of lending fees as an explanatory variable of stock returns. Empirical results are consistent with the theory proposed.
Goethe University Frankfurt
California Institute of Technology
University of Pennsylvania
- G1 - General Financial Markets
- E7 - Macro-Based Behavioral Economics