Preference heterogeneity and asset prices: An exact solution

Research output: Contribution to journalArticlepeer-review

5 Scopus citations


We introduce a general equilibrium model of a multi-agent, pure-exchange economy and find a set of conditions that enable us to obtain explicit closed-form solutions to the equilibrium interest rate, stock price, risk premium and stock market volatility when investors have heterogenous risk aversions. Because the market is dynamically complete, full risk sharing obtains and a representative agent can be constructed, though the risk aversion of this agent fluctuates over time with the state of the economy, as the relative wealth distribution of the individual investors changes. We show that preference heterogeneity can cause asset prices to be significantly more volatile than the underlying dividends and that it can lead to leverage-like effects in volatility, in the sense that volatility increases after stock-market declines.

Original languageEnglish (US)
Pages (from-to)2238-2246
Number of pages9
JournalJournal of Banking and Finance
Issue number9
StatePublished - Sep 2010


  • Closed form solution
  • Preference hererogeneity
  • Risk aversion

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics


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