TY - JOUR AU - Chien,YiLi AU - Cole,Harold AU - Lustig,Hanno TI - A Multiplier Approach to Understanding the Macro Implications of Household Finance JF - National Bureau of Economic Research Working Paper Series VL - No. 13555 PY - 2007 Y2 - November 2007 UR - http://www.nber.org/papers/w13555 L1 - http://www.nber.org/papers/w13555.pdf N1 - Author contact info: Yi-Li Chien 403 West State Street Krannert School of Management Purdue University West Lafayette IN 47907 Tel: 765-494-4438 E-Mail: yilichien@gmail.com Harold L. Cole Economics Department University of Pennsylvania 3718 Locust Walk 160 McNeil Building Philadelphia, PA 19104 Tel: 215-898-7788 E-Mail: colehl@sas.upenn.edu Hanno Lustig UCLA Anderson School of Management 110 Westwood Plaza, Suite C413 Los Angeles, CA 90095-1481 Tel: 310/825-1011 Fax: 310/825-9528 E-Mail: hlustig@anderson.ucla.edu AB - 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 expected returns. To solve the model, we derive an optimal consumption sharing rule that does not depend on the trading technology, and we derive an aggregation result for state prices. This allows us to solve for equilibrium prices and allocations without having to search for market-clearing prices in each asset market separately. We show that the fraction of total wealth held by active traders, not the fraction held by all participants, is critical for asset prices, because only these traders respond to variation in state prices and hence absorb the residual aggregate risk created by non-participants. We calibrate the heterogeneity in trading technologies 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. In contrast to existing models with heterogeneous agents, our model matches the high volatility of returns and the low volatility of the risk-free rate. ER -