Investor Heterogeneity, Aggregation, and the Non-Monotonicity of the Aggregate Marginal Rate of Substitution in the Price of Market-Equity



This paper develops a framework for aggregating the marginal rate of substitution of individual investors under heterogeneity. The heterogeneity in the model stems from differences in personalized return densities, risk aversion, and implied optimal equity positions. When investors ascribe to beliefs that depart from the norm, long and short equity positions become an endogenous feature of the economy as a solution to their portfolio optimization problem. We develop economically motivated restrictions that may give rise to a U-shaped aggregate marginal rate of substitution and present parametric examples that support such economies. The theory is consistent with extant empirical studies and relies on heterogeneous beliefs about return outcomes and short equity positions.
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Ingolf Dittmann