The importance of investor heterogeneity and financial market imperfections for the behavior of asset prices

Abstract

Incomplete markets arising from uninsurable labor income shocks, borrowing constraints, and trading costs have been suggested as the reason for the empirical failure of the representative consumer model. We broadly survey the related literature and experiment with a calibrated model that nests a number of earlier models. The results suggest that while much remains to be explained, a number of apparently robust implications can be drawn that make the traditional assetpricing puzzles much less puzzling.