Dynamic General Equilibrium and T-Period Fund Separation

In a dynamic general equilibrium model, we derive conditions for a mutual fund separation property by which the savings decision is separated from the asset allocation decision. With logarithmic utility functions, this separation holds for any heterogeneity in discount factors, while the generalizat...

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Bibliographic Details
Published inJournal of financial and quantitative analysis Vol. 45; no. 2; pp. 369 - 400
Main Authors Gerber, Anke, Hens, Thorsten, Woehrmann, Peter
Format Journal Article
LanguageEnglish
Published New York, USA Cambridge University Press 01.04.2010
Subjects
Asset pricing
Dividends
Economic models
Economic theory
Endogenous
Equilibrium
Equilibrium prices
Financial portfolios
Heterogeneity
Investors
Prices
Quantitative analysis
Risk
Risk aversion
Risk factors
Time series
Utility functions
Wealth
Yield
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Summary:In a dynamic general equilibrium model, we derive conditions for a mutual fund separation property by which the savings decision is separated from the asset allocation decision. With logarithmic utility functions, this separation holds for any heterogeneity in discount factors, while the generalization to constant relative risk aversion holds only for homogeneous discount factors but allows for any heterogeneity in endowments. The logarithmic case provides a general equilibrium foundation for the growth-optimal portfolio literature. Both cases yield equilibrium asset pricing formulas that allow for investor heterogeneity, in which the return process is endogenous and asset prices are determined by expected discounted relative dividends. Our results have simple asset pricing implications for the time series as well as the cross section of relative asset prices. It is found that on data from the Dow Jones Industrial Average, a risk aversion smaller than in the logarithmic case fits best.
Bibliography:ArticleID:00004
ark:/67375/6GQ-2ZF61H0P-4
We thank an anonymous referee, Stephen Brown (the editor), Mathias Hoffmann, and Karl Schmedders for helpful comments. Gerber was at the University of Zurich at the time the paper was written. Woehrmann did part of the work at the University of Zurich and greatly acknowledges financial support from the Ecoscentia Foundation. Financial support by the National Centre of Competence in Research in “Financial Valuation and Risk Management” is also gratefully acknowledged. The national centers in research are managed by the Swiss National Science Foundation on behalf of the federal authorities.
PII:S0022109010000049
istex:2734CF636710FD53BF090E55AB9E090554F4B365
ISSN:0022-1090
1756-6916
DOI:10.1017/S0022109010000049