English, Article edition: Two-fund separation in dynamic general equilibrium Schmedders, Karl

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Bookmark: http://trove.nla.gov.au/version/111491
Physical Description
  • article
Language
  • English

Edition details

Title
  • Two-fund separation in dynamic general equilibrium
Author
  • Schmedders, Karl
Physical Description
  • article
Notes
  • This paper examines the two-fund separation paradigm in the context of an infinite-horizon general equilibrium model with dynamically complete markets and heterogeneous consumers with time- and state-separable utility functions. With the exception of the dynamic structure, we maintain the assumptions of the classical static models that exhibit two-fund separation with a riskless security. Agents have equi-cautious HARA utility functions. In addition to a security with state-independent payoffs, agents can trade a collection of assets with dividends following a time-homogeneous Markov process. We make no further assumptions about the distribution of asset dividends, returns, or prices. If the riskless security in the economy is a consol then agents' portfolios exhibit two-fund separation. However, if agents can trade only a one-period bond, this result no longer holds. The underlying intuition is that general equilibrium restrictions lead to interest rate fluctuations that destroy the optimality of two-fund separation in economies with a one-period bond and result in different equilibrium portfolios.
  • Portfolio separation, dynamically complete markets, consol, one-period bond, interest rate fluctuation, reinvestment risk
  • RePEc:the:publsh:320
Language
  • English
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