Title: General Equilibrium with Stochastic Benchmarking
Abstract: This paper applies a continuous-time model to study the equilibrium of an economy consisting one normal agent and one constrained agent who has to maintain his intermediate wealth above a stochastic benchmark whose value is determined endogenously. After characterizing the optimization problems, I use the martingale approach to derive the equilibrium market dynamics in closed-form to compare with the normal economy. In the benchmarking economy before the constraint date, asset price, volatility and risk premium are higher than those in the normal economy for risky benchmarks. When the benchmark is relatively safe, asset price is higher but volatility, risk premium and the optimal fraction of wealth invested in the risky asset are decreased.
Publication Year: 2009
Publication Date: 2009-01-01
Language: en
Type: article
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