Do you think that the current investor deleveraging is playing a significant role in asset pricing? If so, has it been consistent with your views on asset pricing? Is this something we should be really concerned about? EFF/KRF: The tools we develop in "Disagreement, Tastes, and Asset Pricing," published in the Journal of Financial Economics 83 (March 2007), 667-689, are helpful here. To keep the analysis simple, let's assume that (i) there is only one stock, (ii) I have $100,000 to invest, and (iii) for some reason, I want to own as much of the stock as possible. Compare two scenarios. In the first I cannot borrow so I just buy $100,000 of equity. In the second scenario, you are willing to lend me money to buy more stock. You are not crazy, however, so you limit my leverage to four to one. With $100,000 to invest I can borrow $400,000 and buy $500,000 of stock.
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