Habits and Leverage

Many stylized facts of leverage, trading, and asset prices follow from a frictionless general equilibrium model that features agents’ heterogeneity in endowments and habit preferences. Our model predicts that aggregate debt increases in good times when stock prices are high, return volatility is low, and levered agents enjoy a “consumption boom.” Our model is consistent with poorer agents borrowing more and with recent evidence on intermediaries’ leverage being a priced factor of asset returns. In crisis times, levered agents strongly deleverage by “fire selling” their risky assets as asset prices drop. Yet, consistently with the data, their debt-to-wealth ratios increase because their wealth decline faster due to higher discount rates. * Columbia Business School, Columbia University, NBER, and CEPR. E-mail: [email protected]. **The University of Chicago Booth School of Business, NBER, and CEPR. E-mail: [email protected]. For their comments, we thank Patrick Bolton, Luigi Guiso, Lars Hansen, and Norman Schrhoff, as well as seminar participants at EIEF (Rome), the 2016 European Summer Symposium in Financial Markets (Switzerland), University of Chicago, EDHEC, Stockholm School of Economics, BI Norwegian Business School, NYU Stern, Bocconi University, and University of Turin. We thank Alejandro Hoyos Suarez for excellent research assistance. This research has been supported by the Fama-Miller Center for Research in Finance and the Center for Research in Security Prices, both located at Chicago Booth.