This article studies an intertemporal economy with liquidity constrained and unconstrained individuals. We use a stopping time approach to solve the finite horizon-constrained consumption portfolio problem with constant relative risk aversion and to examine the structure of equilibrium. The impact of the constraint on the optimal consumption and the financing portfolio is assessed. The equilibrium state price density is related to the exercise boundary of an American-style contingent claim with nonlinear payoff. This stopping time characterization enables us to prove the existence of an equilibrium and can be implemented numerically. Properties of equilibrium bond and stock returns are examined.

This article studies an intertemporal economy with liquidity constrained and unconstrained individuals. We use a stopping time approach to solve the finite horizonconstrained consumption portfolio problem with constant relative risk aversion and to examine the structure of equilibrium. The impact of the constraint on the optimal consumption and the financing portfolio is assessed. The equilibrium state price density is related to the exercise boundary of an American-style contingent claim with nonlinear payoff. This stopping time characterization enables us to prove the existence of an equilibrium and can be implemented numerically. Properties of equilibrium bond and stock returns are examined.

This paper proposes a new simulation‐based approach for optimal portfolio allocation in realistic environments with complex dynamics for the state variables and large numbers of factors and assets. A first illustration involves a choice between equity and cash with nonlinear interest rate and market price of risk dynamics. Intertemporal hedging demands significantly increase the demand for stocks and exhibit low volatility. We then analyze settings where stock returns are also predicted by dividend yields and where investors have wealth‐dependent relative risk aversion. Large‐scale problems with many assets, including the Nasdaq, SP500, bonds, and cash, are also examined.