EQUILIBRIUM WITH EXCESSIVE HOLDINGS CONSTRAINT: AN APPLICATION TO DC PENSION PLANS

Abstract

In this paper, I study the equilibrium implications when some investors in the economy overweight a subset of stocks within their portfolio. I find that the excess returns for the overweighted stocks are lower, all else being equal. This has strong testable implications for stock returns. In the special case of logarithmic preferences, the riskfree rate increases and the market price of risk for the overweighted stock decreases, which create extra incentive for unconstrained agents to exit the stock market and hold bonds, hence clearing the market. The changes of stocks' volatilities are ambiguous. Finally, I provide an accurate quantification for agents' welfare. I also discuss the implications of my model in the context of defined contribution pension plans where workers hold large shares of their employer.