Pietro Veronesi (University of Chicago)

“Habits and Leverage”

Abstract

Many stylized facts of leverage, trading, and asset prices can be explained by a frictionless general equilibrium model in which agents have heterogeneous endowments and external habit preferences. Our model predicts that aggregate leverage increases in good times when stock prices are high and volatility is low, it should predict low future returns and it is positively correlated with a “consumption boom” of levered agents. In addition, negative aggregate shocks induce levered agents to deleverage by “fire selling” their risky positions as their wealth drops. While such agents’ total leverage decreases, their debt/wealth level increases as wealth is especially sensitive to changes in aggregate risk aversion.