DP14257 Incentive Constrained Risk Sharing, Segmentation, and Asset Pricing

Author(s): Bruno Biais, Johan Hombert, Pierre-Olivier Weill
Publication Date: December 2019
Keyword(s): Asset Pricing, Collateral constraints, Endogenously Incomplete, General Equilibrium
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14257

Incentive problems make securities' payoffs imperfectly pledgeable. Introducing these problems in an otherwise canonical general equilibrium model yields a rich set of implications. Security markets are endogenously segmented. There is a basis going always in the same direction: the price of any risky security is lower than that of the replicating portfolio of Arrow securities. Equilibrium expected returns are concave in consumption betas, in line with empirical findings. As the dispersion of consumption betas of the risky securities increases, incentive constraints are relaxed and the basis reduced. When hit by adverse shocks, relatively risk tolerant agents sell their safest securities.