Incentive Constrained Risk Sharing, Segmentation, and Asset Pricing (with Bruno Biais and Pierre-Oliv ier Weill)
Abstract:
We analyse a
one-period general equilibrium asset pricing model with standard corporate
finance frictions (cash-diversion). Incentive compatibility constraints imp
ly that the market is endogenous incomplete. They also induce endogenous se
gmentation, as different types of investors hold different assets in equili
brium, and co-movements in asset prices. Equilibrium expected excess return
s reflect two premia: a risk premium, which is positive if the return on th
e asset is large when the pricing kernel is low, but which does not reflect
aggregate or individual consumption due to incentive compatibility constra
ints; and a divertibility premium, which is positive if the return on the a
sset large when incentive-compatibility constraints bind. This divertibilit
y premium is inverse-U shaped with betas, in line with the empirical findin
gs that the security market line is flat at the top.