Incomplete Diversification And Asset Pricing

QED Working Paper Number
1081

Investors in equilibrium are modeled as facing investor specific risks across the space of assets. Personalized asset pricing models reflect these risks. Averaging across the pool of investors we obtain a market asset pricing model that reflects market risk exposures. It is observed on invoking a law of large numbers applied to an infinite population of investors, that many personally relevant risk considerations can be eliminated from the market asset pricing model. Examples illustrating the effects of undiversified labor income and taste specific price indices are provided. Suggestions for future work on asset pricing include a need to focus on identifying and explaining investor specific risk exposures.

Author(s)

Robert Elliott
Dilip B. Madan

JEL Codes

Keywords

Diversification
Asset Pricing
Investor specific risks

Working Paper

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