ASSET PRICING WITH BORROWING CONSTRAINTS AND EX ANTE HETEROGENEITY

Abstract

In answer to the question “Will borrowing constraints necessarily intensify aggregate fluctuations and aggregate cyclical variability?” it has been found that complete markets equilibrium displays aggregate fluctuations that may be dampened when borrowing constraints are introduced. Like others, I find that variability in the distribution of labor productivity shocks amplifies aggregate fluctuations. I also find that allowing agents to have different permanent incomes amplifies aggregate fluctuations, enriching the asset-pricing implications of the complete contingent claims model when demand aggregation is not possible. Although agents are able to equalize their intertemporal marginal rates of substitution (IMRS) of consumption state-by-state, the IMRS of labor is not equalized across agents, creating gains from specialization. To determine how frictions affect aggregate variability, two types of borrowing constraints are studied. In the first model, dividend payments are restricted and, in the second, nonhuman wealth is restricted to be positive. Either type of borrowing constraint can dampen aggregate fluctuations.