This paper analyzes the effects of buy and hold investors on security price dynamics in a pure-exchange, continuous-time model. Empirical studies suggest that many defined contribution plan participants follow buy and hold strategies by rarely changing asset and flow allocations due to information costs or other frictions. A buy and hold investor effectively faces an incomplete market and differs in her pricing of risk from a dynamic asset allocator. Construction of an equilibrium is achieved through a representative agent with state-dependent utility. The fraction of the stock held by the buy and hold investor emerges as an additional state variable. Characterization of equilibrium quantities is given analytically as function of the state variables. A simple calibration of our model shows that the economy with buy and hold investors can simultaneously produce a low interest rate and a high Sharpe ratio. At the same time, the model can deliver a stock return volatility more than twice that in the limited participation model while keeping interest rate volatility at reasonably low levels. Intuition for these results is also provided.
