Dynamic Equilibrium with Heterogeneous Agents and Risk Constraints∗

We examine the impact of risk-based portfolio constraints on asset prices in an exchange economy. We show that constrained agents scale down their portfolio and behave locally like power utility investors with risk aversion that depends on current market conditions. In contrast to previous results in the literature, we show that the imposition of constraints dampens fundamental shocks, challenging the idea that risk management rules amplify aggregate fluctuations. We find that risk constraints may give rise to bubbles in asset prices, and connect these results to portfolio imbalances generated by the constraints, asset shortages and the heterogeneity across agents. JEL Classification: D51, D52, D53, G11, G12.