TY  - JOUR
AU  - Alvarez,Fernando
AU  - Jermann,Urban J.
TI  - Asset Pricing when Risk Sharing is Limited by Default
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 6476
PY  - 1998
Y2  - March 1998
UR  - http://www.nber.org/papers/w6476
L1  - http://www.nber.org/papers/w6476.pdf
N1  - Author contact info:
Fernando E. Alvarez
University of Chicago
Department of Economics
1126 East 59th Street
Chicago, IL 60637
Tel: 773/702-4412
Fax: 773/702-8490
E-Mail: f-alvarez1@uchicago.edu

Urban Jermann
Finance Department
Wharton School of the University of Pennsylvania
3620 Locust Walk
Philadelphia, PA  19104
Tel: 215/898-4184
Fax: 215/898-6200
E-Mail: jermann@wharton.upenn.edu
AB  - We study the asset pricing implications of a multi-agent endowment economy where agents can default on contracts that would leave them otherwise worse off.  We specialize and extend the environment studied by Kocherlakota (1995) and Kehoe and Levine (1993) to make it comparable to standard studies of asset pricing.  We make contributions along two fronts.  First, we extend the characterization of efficient allocations.  Second, we present an equilibrium concept with complete markets and with endogenous solvency constraints.  These solvency constraints are such as to prevent default at the cost of reduced risk sharing. We show a version of the classical welfare theorems for this equilibrium definition.  We characterize the pricing kernel, and compare it to the one for economies without participation constraints: interest rates are lower and risk premia can be bigger depending on the covariance of the idiosyncratic and aggregate shocks.  We show that those agents whose endowment is very similar to the aggregate endowment are irrelevant for asset pricing.  In a quantitative example, for reasonable parameter values, the relevant marginal rates of substitution fall within the Hansen-Jagannathan bounds.
ER  -