This paper assesses the importance of heterogeneity in household portfolios for transmission monetary policy a New Keynesian business cycle model with uninsurable income risk and assets different liquidity. In this environment, works through investment, but redistribution lowers elasticity investment via two channels: (i) marginal propensities to invest, (ii) time variation liquidity premium. M...

This paper derives optimal asset allocations (which assets to hold) and asset locations (in which accounts to hold them) for a risk-averse investor saving for retirement. The investor can hold taxable corporate bonds, tax-exempt municipal bonds, and stocks either in a tax-deferred or a conventional taxable savings account. Taxable bonds have a preferred location in the taxdeferred account and t...

Over the past 75 years, common stocks performed better under Democrats, while U.S. government bonds and Treasury (T) bills performed better under Republicans. Using a mean-variance framework, we find that Democrats provide better risk-reward opportunities for portfolios weighted toward stocks, while Republicans provide better tradeoffs for portfolios weighted toward government bonds and T-bills...

This paper considers the role of corruption in impelling capital flight. Identifying corruption as one dimension of poor governance, the empirical analysis explores direct linkages between corruption and capital flight in a broad sample of countries. The novelty of this investigation is that it is based on a portfolio choice model of asset allocation that explicitly recognizes corruption as con...

Money managers are rewarded for increasing the value of assets under management. This gives a manager an implicit incentive to exploit the well-documented positive fund-flows to relative-performance relationship by manipulating her risk exposure. The misaligned incentives create potentially significant deviations of the manager’s policy from that desired by fund investors. In the context of a f...

Credit default swaps (CDS) are similar to out-of-the-money put options in that both offer a low cost and effective protection against downside risk. This study investigates whether put optionimplied volatility is an important determinant of CDS spreads. Using a large sample of firms with both CDS and options data, we find that individual firms’ put option-implied volatility dominates historical...

We propose an equilibrium model to study the impact of short-sale constraints on market prices and liquidity in imperfectly competitive markets where market makers have significant market power and are averse to inventory risk. We show that shortsale constraints decrease bid because of the market power and increase ask because of the risk aversion. Our model can therefore help explain why short...

We investigate how the inability to continuously trade an asset affects portfolio choice. We extend the standard Merton model to include an illiquid asset that can only be traded at infrequent, stochastic intervals. Because consumption is financed through liquid wealth only, the presence of illiquidity leads to increased and state-dependent risk aversion. Illiquidity leads to under-investment i...

Our objective in this article is to study analytically the effect of borrowing constraints on asset returns. We explicitly characterize the equilibrium for an exchange economy with two agents who differ in their risk aversion and are prohibited from borrowing. In a representative-agent economy with CRRA preferences, the Sharpe ratio of equity returns and the riskfree rate are linked by the risk...

This paper shows that the diversification choices of individual investors influence stock returns. A zero-cost portfolio that takes a long (short) position in stocks with the least (most) diversified individual investor clientele generates an annual, risk-adjusted return of 5–9%. This spread reflects the combined effects of sentiment-induced mispricing, narrow risk framing, and asymmetric infor...