an equilibrium model with restricted stock market...
TRANSCRIPT
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An Equilibrium Model with Restricted Stock Market Participation
S. Basak, D. CuocoPresented by Yoel Krasny
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Outline
Introduction
The ModelEconomyUnrestricted caseRestricted caseExample
Discussion
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Limited Participation –Empirical findings
72.4% of the households held no stock at all (as of 1984) but accounted for 68% of aggregate food expenditures
52.3% of the HH, holdings other liquid assets in excess of 100,000$, held no stock at all
The fraction of HH owning stocks increases with average labor income and education
Aggregate consumption of Stock holders is more volatile and correlated with the equity risk premia
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Main Insight
Two types of investors:Non-participants – trade only bondsParticipants – trade both stocks and bonds
The non-participants have a smooth consumption process stock holders are left alone to bear the aggregate risk of the equity market stock holders demand an higher equity premium
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Outline
Introduction
The ModelEconomyUnrestricted caseRestricted caseExample
Discussion
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The Economy
Information StructureProbability Space – (Ω, f, F, P)One dimensional Brownian Motion –Information Set determined by W(t)
Consumption SpaceA single perishable goodThe consumption process c(t) is nonnegative and progressively measurable
],0[),( TttW ∈
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The Economy - Securities
Exogenous positive dividend process
Endogenous bond price process
Endogenous Stock price – claim to dividend stream
dttBtrtdB )()()( =
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The Economy – Trading Strategies
Admissible trading strategy is a vector process (α(t),θ(t)) – amounts invested in (bond, stock)
Trading strategy is said to finance the consumption plan c(t):
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Two agents, each with
Agent 1:Has access to both the bond and stock marketU(c) satisfies the Inada conditionEndowed with (-β shares of bond, 1 share of stock)
Agent 2: Prevented from investing in the stock marketU(c) = log(c)Endowed with (β shares of bond, 0 shares of stock)
The Economy – Agents
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The Economy – Equilibrium
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Outline
Introduction
The ModelEconomyUnrestricted caseRestricted caseExample
Discussion
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The Unrestricted case –Representative agent
The second agent can trade the stockEquilibrium is constructed by replacing the two agents with a single representative agent as in Huang (1987)The representative agent is
Endowed with the aggregate supply of securities Has the following utility function:
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Solving the Unrestricted case
)),0(()),(()(λδλδε ρ
c
ct
UtUet −=
The Marginal Rate of Substitution є(t) is the pricing kernel
tXX dWtdtttdX )()()( σμ +=Let X(t) be some security:
t
t
t
WttXtdMTGistXt
sXsEttX
sXtsEtXst
⋅=⇒⇒
=⇒⎭⎬⎫
⎩⎨⎧
=<∀
)()()()()(
)()()()(
)()()()(:
ψεε
εεεε
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Solving the Unrestricted case
tXX dWtdtttdX )()()( σμ +=
[ ] tXX dWdtttXtttXtd ...)()()()()()( +++= εε σσμμεε
0)()()()( =++ εε σσμμε XX ttXtt
)()()()()()( trttdttBtrtdB ⋅−=⇒= εμε
tdWtStdttSttdS )()()()()( σμ +=
)()()()()(
ttrttt
σμεσε
−⋅−=⇒
ITO
K(t)
MTG
Bond
Stock
tdWtdtttd )()()( εε σμε +=
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Solving the Unrestricted case
).),(()),0(()),(()( ttf
UtUet
c
ct δλδλδε ρ == −
))0((
))(()())(()())(()(2
21
δδρσδμδμ
ρ
εc
cdcccdcct
UtUttUttUet −+
=−
))0(()())(()(
δσδσ
ρ
εc
dcct
UttUet
−
=
tdWtdtttd )()()( εε σμε +=
tdWtdtttd )()()( δδ σμδ +=
ITO
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)()()()()()( 22
1 ttPtAttAtr dd σμρ −+=
;)),(()),(()(;
)),(()),(()(
λδλδ
λδλδ
tUtUtP
tUtUtA
cc
ccc
c
cc −=−=
)()()( ttAtk dσ=
Solving the Unrestricted case
Interest Rate
Market Price of Risk
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)()()()()()( 22
1 ttPtAttAtr dd σμρ −+=
)()()( ttAtk dσ=
Solving the Unrestricted case
Interest Rate
Market Price of Risk
[ ] [ ]122
21
11 +++ Δ−Δ⋅+−= ttttf
t ccElanr σγγδ
[ ] [ ][ ] [ ]111
1
12
21
11 ),( ++++
+++ ΔΔ=+−
ttp
tttptt
ptt
ft
ptt crc
rrrrE σγρ
σσ
Discrete
Discrete
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Solving the Unrestricted case –getting individual consumption
ITO
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Solving the Unrestricted case –Choosing λ
λ is chosen such that the budget constraint for agent 2 is satisfied:
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Outline
Introduction
The ModelEconomyUnrestricted caseRestricted caseExample
Discussion
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The Restricted case – Rep. agent
Second Agent does not face a complete marketEquilibrium consumption allocation is not efficientFollowing Cuoco and He (1994) – Aggregation in case of incomplete market
))(()())((max)),(( 2211 tcuttcutcu ⋅+= λλ
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MRS is the SDF
MRS follows
Agent 1 is facing a complete market
Agent 2 invests in bond and has log utility (He and Pearson 1991)
Solving the Restricted case
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Use the above to get the evolution of lamda
Lamda is negatively correlated with aggregate consumption
If the given dividend process is Markovian:Unrestricted case – δ(t) is the state of the economyRestricted case – (δ(t), λ(t)) is the state
Solving the Restricted case
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;))(),(())(),(()(;
))(),(())(),(()(
ttUttUtP
ttUttUtA
cc
ccc
c
cc
λδλδ
λδλδ
−=−=
Solving the Restricted case
Interest Rate
Market Price of Risk
;)1()(;)(c
tPc
tA +==
γγCRRA
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Solving the Restricted case
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Restricted case - Calibration
Following Mehra and Prescott (1985), calibrate:
Stockholders have CRRA utility Now, MPR and interest rate depend only on consumption share of non-stockholders Ф:
0357.0)(
,0183.0)(
==ttdd
δσ
δμ
)1(0357.0
)1)(()(0357.0
)1)(()( 1 φ
γφδδγ
φδσγσ
−=
−⋅
=−
⋅=⋅=
tt
tAtk d
d
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Market Price of Risk
)1(0357.0)(
φγ
−=tk
RA of 3.3, real interest rate of 1.3%
Ф
Mehra and Prescott’s estimated MPR
0.68
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Interest Rate
Ф
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Outline
Introduction
The ModelEconomyUnrestricted caseRestricted caseExample
Discussion
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Example
Both agents have log utility
Dividend growth follows
Now, Lamda represents consumption ratio
)()(
))(())(()(
1
2
2'2
1'1
tctc
tcutcut ==λ
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Example - results
Unrestricted Restricted
r(t)
K(t)
dλ(t) 0
C1(t)
C2(t)
2dd σμρ −+ 2))(1(
dtd σλμρ +−+
( ) tdWttd
22)()( σλλ ⋅+−
λδ+1
)(t
λλδ+1
)(t
( ) ( )dd
tttttt cdc σλσσλλμμ )(1)(,)()()()( 22 +=++=
( ) 0)(,)()()()( 22 =+−= ttttt cdc dσσλλμμ
dσ ( )
dt σλ )(1+
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Simulation
1.0001.0
000,1001
0357.00183.0
0
======
dt
T
d
d
ρ
λσμ
Simulated 1000 years with:
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Unrestricted - consumption
0.4
0.8
1.2
1.6
2.0
2.4
2.8
3.2
3.6
4.0
250 500 750 1000
U_C1 U_C2 DIV
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Securities
0
1
2
3
4
5
6
250 500 750 10000.0E+00
1.0E+07
2.0E+07
3.0E+07
4.0E+07
5.0E+07
6.0E+07
9000 9250 9500 9750 10000
Stock Bond
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Restricted - consumption
StockHolder NonStock Agg
0.0
0.4
0.8
1.2
1.6
2.0
2.4
250 500 750 10000.00E+00
5.00E+06
1.00E+07
1.50E+07
2.00E+07
2.50E+07
3.00E+07
9000 9250 9500 9750 10000
Unrestricted
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Consumption Growth -Shocks
-.04
-.03
-.02
-.01
.00
.01
.02
.03
10 11 12 13 14 15 16 17 18 19 20
restricted - agent 1restricted - agent 2unrestricted - agent 1/2DDIV
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Consumption Growth –Correlations and Stdevs
Stdev
DDIV DC1 DC2 DC_U
DDIV 1.000000 0.993561 0.071014 1.000000
DC1 0.993561 1.000000 0.033538 0.993561
DC2 0.071014 0.033538 1.000000 0.071014
DC_U 1.000000 0.993561 0.071014 1.000000
0.023346 0.017383 0.000553 0.011673
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Lamda
0.2
0 .4
0 .6
0 .8
1 .0
1 .2
1 .4
1 .6
1 .8
2500 5000 7500 10000
Unrestr ic ted Restr ic ted
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MPR
.0 3
.0 4
.0 5
.0 6
.0 7
.0 8
.0 9
.1 0
2 5 0 0 5 0 0 0 7 5 0 0 1 0 0 0 0
R e s tr i c te d U n re s tr i c te d
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Interest Rate
.0156
.0160
.0164
.0168
.0172
.0176
.0180
.0184
2500 5000 7500 10000
Unre stric ted Restric te d
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Outline
Introduction
The ModelEconomyUnrestricted caseRestricted caseExample
Discussion
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Discussion - Theoretical
Participation in the model is determined only by the wealth held by each type of agent, however:
As financial markets become more accessible, participation increases (1989 2002: 74% increase)Participation might decrease in bad times
Model indirectly considers non-participants to be less risk-averse, however, the opposite is more reasonable
Dependence of the results on utility specification:Agent 1 utility – ARA must decrease with c Agent 2 log utility no hedging demands consumption of agent 2 even smoother
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Discussion – Empirical
The following should vary with participation:Equity Premium (negative relationship)Interest Rate (positive)
Test implications:Time Series – historical dataCross Section – across countries
Endogeneity issues?