Asset Pricing with Heterogeneously Attentive Investors: An Application of the US Municipal Bond Market
Ehsan Azarmsa, Joint Program in Financial Economics PhD student
Financial markets feature investors that are heterogeneously attentive to the market trends (Duffie, 2010). This paper examines the asset pricing implications of this heterogeneity within a general equilibrium framework. The model features two types of investors: Attentive investors, who continuously adjust their consumption based on the aggregate output, and inattentive investors, who adjust their consumption path intermittently. I show that due to this infrequent adjustment, the lags of aggregate consumption impact the current wealth and consumption of attentive investors, and thus appear in their SDF. It causes them to behave as if they have external habit preferences, with the size of their maturing liabilities resembling their “habit” state, while all investors have standard CRRA preferences. In contrast to most leading asset pricing models, the term-structure of the equity premium and Sharpe ratios are downward-sloping. The model explains several well-documented asset pricing phenomena, such as the high risk-premium, high return volatility, low interest rate, and return predictivity. The model is highly tractable and all prices and allocations are derived in closed-form for some non-trivial cases.