Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing
AbstractThe authors examine an economy with aggregate and idiosyncratic income risk in which agents cannot contract on future labor income. Agents trade financial securities to buffer idiosyncratic shocks but the extent of trade is limited by borrowing constraints and transactions costs. The effect of frictions on the equity premium is decomposed into two components: a direct effect due to the equation of net-of-costs margins and an indirect effect due to increased consumption volatility. Simulations suggest that the direct effect dominates and that the model predicts a sizable equity premium only if costs are large or the quantity of tradable assets is limited. Copyright 1996 by University of Chicago Press.
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Bibliographic InfoArticle provided by University of Chicago Press in its journal Journal of Political Economy.
Volume (Year): 104 (1996)
Issue (Month): 3 (June)
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Web page: http://www.journals.uchicago.edu/JPE/
Other versions of this item:
- John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
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