Henri Pagès

Labor Income, Borrowing Constraints, and Equilibrium Asset Prices

SummaryWe develop a duality approach to study an individuals optimal consumption and portfolio policy when the individual has limited opportunities to borrow against future labor income and cannot totally insure the risk of income fluctuations. The individuals intertemporal consumption and portfolio problem is cast in a continuous-time setting under uncertainty. We transform the individuals intertemporal problem into a dual shadow prices problem that solves the shadow prices for the individuals optimal consumption plan or equivalently the individuals intertemporal marginal rates of substitution. We show that the shadow prices process can be expressed as a product of a martingale and a decreasing process (normalized by the bond price). The existence of an optimal solution to the individuals intertemporal consumption and portfolio problem is established via duality. The duality approach also allows us to characterize in a sample way the individuals optimal consumption and portfolio policy in the presence of labor income and borrowing constraints. Equilibrium implications of borrowing constraints on asset prices are also discussed in the paper.

Can Liquidity Risk be Subsumed in Credit Risk? A Case Study from Brady Bond Prices

The paper applies a reduced-form model to uncover from secondary markets Brady bond prices, together with Libor interest rates, how the risk of sovereign default is perceived to depend upon time. The methodology is implemented on a particular issue, a discount bond issued by Brazil and maturing in April 2024. It is shown that subsuming liquidity risk in default risk may result in a misspecified model that, while generating the desired negative correlation between credit spreads and default-free interest rates, also generates negative probabilities of default at long horizons.

A Note on the Gordon Growth Model with Nonstationary Dividend Growth

Researchers have sometimes argued that the recent ascent in stock prices could be explained in some measure by changes in expectations about long-run future dividend growth. For example, Barsky and De Long (1993) argue that a small random walk component in the growth rate of dividends, when extrapolated into the future, is capable of reproducing the large swings in US stock prices over the period 1880-1990. I show that the hypothesis of a nonstationary permanent growth rate of dividends is inconsistent with the Gordon growth model.