Dynamic Equilibrium with Liquidity Constraints

This article studies an intertemporal economy with liquidityconstrained and unconstrained individuals. We use a stoppingtime approach to solve the finite horizonconstrained consumptionportfolio problem with constant relative risk aversion and toexamine the structure of equilibrium. The impact of the constrainton the optimal consumption and the financing portfolio is assessed.The equilibrium state price density is related to the exerciseboundary of an American-style contingent claim with nonlinearpayoff. This stopping time characterization enables us to provethe existence of an equilibrium and can be implemented numerically.Properties of equilibrium bond and stock returns are examined.