Portfolio Choice and Asset Prices when Preferences are Interdependent

Journal of Economic Behavior & Organization, Vol. 140, pp. 197-223

Giuliano Curatola
Research Area:
Macro Finance
Aug 2017
Asset pricing; General equilibrium; heterogeneous investors; interdependent preferences; portfolio choice

This paper studies the implications of interdependent preferences for investors’ portfolios and the dynamics of asset prices. Individual preferences are interdependent because they depend on other people's consumption and, thus, change over time. In equilibrium, investors herd and hold the same portfolio of risky assets, which is biased toward stocks of sectors that produce a socially preferred good. Price-dividend ratios, expected returns, and return volatility are time-varying, and their dynamics are directly linked to changes in preferences. These results hold even in economies with very simple ingredients, such as logarithmic preferences, and are in stark contrast with those obtained in standard models where preferences are not interdependent.

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