Young, Old, Conservative, and Bold: The Implications of Heterogeneity and Finite Lives for Asset Pricing

Abstract

We study the implications of preference heterogeneity for asset pricing. We use recursive preferences in order to separate heterogeneity in risk aversion from heterogeneity in the intertemporal elasticity of substitution and an overlapping-generations framework to obtain a nondegenerate stationary equilibrium. We solve the model explicitly up to the solutions of ordinary differential equations and highlight the effects of overlapping generations and each dimension of preference heterogeneity on the market price of risk, interest rates, and the volatility of stock returns. We find that separating intertemporal elasticity of substitution and risk aversion heterogeneity can have a substantive impact on the model’s (qualitative and quantitative) ability to address some key asset-pricing issues.