Optimality and Asset Pricing under Large Agents

Jussi Keppo
2002 Social Science Research Network  
This paper examines the optimal consumption and investment problem and equilibrium asset pricing in the case of large agents. Because of the investors' significant market power, the prices of financial assets depend on the agents' behavior. The optimal consumption and wealth processes of a single large agent are the same as under small agents and the optimal investment strategy is a nonlinear function of the corresponding small agent's strategy. Because of this nonlinear function, in
more » ... tion, in equilibrium the expected return of a risky asset might be different from the corresponding return under small agents. However, if the market's representative large agent has a deterministic endowment process then the equilibrium market price of risk is given by the market portfolio's volatility and it is independent of the large agent price effect. We also illustrate how our model can be used to describe price shocks in the market and how the representative agent strengthens price movements. JEL classifications: G11, G12, D50.
doi:10.2139/ssrn.296790 fatcat:zp6tq7eoq5hejcxywlijhk4q7u