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American Economic Review: Vol. 102 No. 6 (October 2012)

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Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Rebalancing?

Article Citation

Chien, YiLi, Harold Cole, and Hanno Lustig. 2012. "Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Rebalancing?" American Economic Review, 102(6): 2859-96.

DOI: 10.1257/aer.102.6.2859

Abstract

Our paper examines whether the failure of unsophisticated investors to rebalance their portfolios can help to explain the countercyclical volatility of aggregate risk compensation in financial markets. To answer this question, we set up a model in which a large mass of investors do not rebalance their portfolio shares in response to aggregate shocks, while a smaller mass of active investors do. We find that intermittent rebalancers more than double the effect of aggregate shocks on the time variation in risk premia by forcing active traders to sell more shares in good times and buy more shares in bad times. (JEL D14, E32, G11, G12)

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Authors

Chien, YiLi (Federal Reserve Bank of St Louis)
Cole, Harold (U PA)
Lustig, Hanno (UCLA)

JEL Classifications

D14: Personal Finance
E32: Business Fluctuations; Cycles
G11: Portfolio Choice; Investment Decisions
G12: Asset Pricing; Trading volume; Bond Interest Rates


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