Investor heterogeneity, asset pricing and volatility dynamics

Research output: Contribution to journalArticlepeer-review

26 Scopus citations


We provide an explicit characterization of the equilibrium when investors have heterogeneous risk preferences. Given market completeness, investors can achieve full risk sharing. Thus, a representative agent can be constructed, though this agent's risk aversion changes over time as the relative wealths of the individual investors change. We show that volatility depends on the covariance of aggregate risk aversion and stock returns. We find that heterogeneity increases volatility, produces volatility clustering (ARCH effects) and "leverage"-like effects. Option prices exhibit implied volatility skews. There is predictability and we assess the magnitude of investors' hedging demands and trading volume. Further, diversity is beneficial to all agents and entails welfare gains that can be substantial.

Original languageEnglish (US)
Pages (from-to)1379-1397
Number of pages19
JournalJournal of Economic Dynamics and Control
Issue number7
StatePublished - Jul 2009
Externally publishedYes


  • Asset pricing
  • Preference heterogeneity
  • Volatility

ASJC Scopus subject areas

  • Economics and Econometrics
  • Control and Optimization
  • Applied Mathematics


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