Quantitative Asset Pricing Implications of Endogenous Solvency Constraints

Posted: 19 Sep 2001

See all articles by Fernando Alvarez

Fernando Alvarez

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Urban J. Jermann

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

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Abstract

We study the asset pricing implications of an economy where solvency constraints are endogenously determined to deter agents from defaulting while allowing as much risk-sharing as possible. We solve analytically for efficient allocations and for the corresponding asset prices, portfolios holdings, and solvency constraints for a simple example. Then we calibrate a more general model to U.S. aggregate as well as idiosyncratic income processes. We find equity premia, risk premia for long-term bonds, and Sharpe ratios of magnitudes similar to the U.S. data for low risk aversion and a low time-discount factor.

Suggested Citation

Alvarez, Fernando and Jermann, Urban J., Quantitative Asset Pricing Implications of Endogenous Solvency Constraints. Available at SSRN: https://ssrn.com/abstract=273868

Fernando Alvarez

University of Chicago - Department of Economics ( email )

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Urban J. Jermann (Contact Author)

University of Pennsylvania - Finance Department ( email )

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