Heterogeneous preferences, investment, and asset pricing

Abstract

We present a production-based model in which agents have heterogeneous risk aversion and heterogeneous discount rate. Compared to the exchange economy, the aggregate consumption-capital ratio and aggregate consumption volatility is reduced. The risk premium and the volatility of stock return increase when moving from the exchange economy to the production economy. We also find that the volatility of Tobin's q exhibits an inverted-U-shape and Tobin's q is procyclical.