Equilibrium Asset Pricing in Directed Networks
Journal article, Peer reviewed
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Original versionReview of Finance, Volume 25, Issue 3, May 2021, Pages 777–818, 10.1093/rof/rfaa035
Directed links in cash flow networks affect the cross-section of risk premia through three channels. In a tractable consumption-based equilibrium asset pricing model, we obtain closed-form solutions that disentangle these channels for arbitrary directed networks. First, shocks that can propagate through the economy command a higher market price of risk. Second, shock-receiving assets earn an extra premium since their valuation ratios drop upon shocks in connected assets. Third, a hedge effect pushes risk premia down: when a shock propagates through the economy, an asset that is unconnected becomes relatively more attractive and its valuation ratio increases.