Is the Volatility of the Market Price of Risk due to Intermittent Portfolio Re-balancing?

Our paper examines whether intermittent portfolio re-balancing on the part of some stock market investors can help to explain the counter-cyclical volatility of aggregate risk compensation in financial markets. To answer this question, we set up an incomplete markets model in which CRRA-utility investors are subject to aggregate and idiosyncratic shocks and have heterogeneous trading technologies. In our model, a large mass of passive investors do not re-balance their portfolio shares in response to aggregate shocks, while a smaller mass of active investors adjust their portfolio each period to respond to changes in the investment opportunity set. We find that intermittent re-balancers amplify the effect of aggregate shocks on the time variation in risk premia by a factor of three in a calibrated version of our model.

You may purchase this paper on-line in .pdf format from SSRN.com ($5) for electronic delivery.

Machine-readable bibliographic record - MARC, RIS, BibTeX