Our paper examines the impact of heterogeneous trading technologies for households on asset prices and the distribution of wealth. We distinguish between passive traders who hold fixed portfolios of stocks and bonds, and active traders who adjust their portfolios to changes in the investment opportunity set. In the presence of non-participants, the fraction of total wealth held by active traders is critical for asset prices, because only these traders respond to variation in state prices and hence help to clear the market, not the fraction of wealth held by all agents that participate in asset markets. We calibrate this heterogeneity to match the equity premium and the risk-free rate. The calibrated model reproduces the skewness and kurtosis of the wealth distribution in the data. To solve the model, we develop a new method that relies on an optimal consumption sharing rule and an aggregation result for state prices. This result allows us to solve for equilibrium prices and allocations without having to search for market-clearing prices in each asset market separately. Our paper examines the impact of heterogeneous trading technologies for households on asset prices and the distribution of wealth. We distinguish between passive traders who hold fixed portfolios of stocks and bonds, and active traders who adjust their portfolios to changes in the investment opportunity set. In the presence of non-participants, the fraction of total wealth held by active traders is critical for asset prices, because only these traders respond to variation in state prices and hence help to clear the market, not the fraction of wealth held by all agents that participate in asset markets. We calibrate this heterogeneity to match the equity premium and the risk-free rate. The calibrated model reproduces the skewness and kurtosis of the wealth distribution in the data. To solve the model, we develop a new method that relies on an optimal consumption sharing rule and an aggregation result for state prices. This result allows us to solve for equilibrium prices and allocations without having to search for market-clearing prices in each asset market separately.
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This paper was revised on June 17, 2008
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