Habits and Leverage (with Tano Santos)
Abstract:
Many styliz
ed facts about leverage, trading, and asset prices can be explained by a fr
ictionless general equilibrium model with countercyclical uncertainty and h
eterogeneous agents with external habit preferences. Our model predicts tha
t aggregate leverage increases in good times, it should predict low future
returns and should be correlated with a “consumption boom” of levered agent
s. In addition, negative aggregate shocks induce leveraged agents to deleve
rage by “fire-selling” their risky positions as their wealth drops. While s
uch agents’ total leverage decreases, their debt/wealth level increases as
wealth value is especially sensitive to changes in aggregate risk aversion.