Is the Volatility of the Market Price of Risk due to Intermittent Portfolio Re-balancing?
Our paper examines whether the well-documented failure of unsophisticated investors to rebalance their portfolios can help to explain the enormous counter-cyclical volatility of aggregate risk compensation in financial markets. To answer this question, we set up a model in which CRRA-utility investors have heterogeneous trading technologies. In our model, a large mass of 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 these intermittent re-balancers more than double the effect of aggregate shocks on the time variation in risk premia by forcing active traders to sell more shares in good times and buy more shares in bad times.
We would like to thank three anonymous referees, our editor Mark Gertler, Fernando Alvarez, Andrew Ang, Michael Brennan, Markus Brunnermeier, Bruce Carlin, Hui Chen, Bhagwan Chowdry, Bernard Dumas, Martin Lettau, Leonid Kogan, Stefan Nagel, Stavros Panageas, Monika Piazzesi and Martin Schneider, as well as the participants of SITE's 2009 Asset Pricing session and the 1st annual workshop at the Zurich Center for Computational Economics, the NBER EFG meetings in San Francisco, the NBER AP meetings in Boston, the ES sessions at the ASSA meetings in Atlanta and seminars at Columbia GSB, UCLA Anderson and MIT Sloan, for helpful comments. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
YiLi Chien & Harold Cole & Hanno Lustig, 2012. "Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Rebalancing?," American Economic Review, American Economic Association, vol. 102(6), pages 2859-96, October. citation courtesy of