
doi: 10.2139/ssrn.908587
handle: 10419/31251 , 10419/150094 , 1807/9746
This paper examines the two-fund separation paradigm in the context of an infinite-horizon general equilibrium model with dynamically complete markets and heterogeneous consumers with time- and state-separable utility functions. With the exception of the dynamic structure, we maintain the assumptions of the classical static models that exhibit two-fund separation with a riskless security. Agents have equi-cautious HARA utility functions. In addition to a security with state-independent payoffs, agents can trade a collection of assets with dividends followingatime-homogeneousMarkovprocess. Wemakenofurtherassumptions about the distribution of asset dividends, returns, or prices. If the riskless security in the economy is a consol then agents’ portfolios exhibit two-fund separation. However, if agents can trade only a one-period bond, this result no longer holds. The underlying intuition is that general equilibrium restrictions lead to interest rate fluctuations that destroy the optimality of two-fund separation in economies with a one-period bond and result in different equilibrium portfolios.
oneperiod bond, consol, one-period bond, ddc:330, dynamically complete markets, interest rate fluctuation, 332, Portfolio separation, dynamically complete markets, consol, one-period bond, interest rate fluctuation, reinvestment risk, Portfolio separation, G11, G12, reinvestment risk, D53, jel: jel:D53, jel: jel:G12, jel: jel:G11
oneperiod bond, consol, one-period bond, ddc:330, dynamically complete markets, interest rate fluctuation, 332, Portfolio separation, dynamically complete markets, consol, one-period bond, interest rate fluctuation, reinvestment risk, Portfolio separation, G11, G12, reinvestment risk, D53, jel: jel:D53, jel: jel:G12, jel: jel:G11
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