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(UBS Pensions Series 035) Asset Pricing with Limited Risk Sharing and Heterogeneous Agents

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  • Francisco Gomes
  • Alex Michaelides

    ()

Abstract

We solve a model with incomplete markets and heterogeneous agents that generates a large equity premium, while simultaneously matching stock market participation and individual asset holdings. The high risk premium is driven by incomplete risk sharing among stockholders, which results from the combination of borrowing constraints and (realistically) calibrated life-cycle earnings profiles, subject to both aggregate and idiosyncratic shocks. We show that it is challenging to simultaneously match aggregate quantities (asset prices) and individual quantities (asset allocations). Furthermore, limited participation has a negligible impact on the risk premium, contrary to the results of models where it is imposed exogenously.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp537.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp537.

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Date of creation: Apr 2005
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Handle: RePEc:fmg:fmgdps:dp537

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Web page: http://www.lse.ac.uk/fmg/

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