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Limited Capital Market Participation and Human Capital Risk

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  • Jonathan Berk
  • Johan Walden
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    Abstract

    The non-tradability of human capital is often cited for the failure of traditional asset pricing theory to explain agents' portfolio holdings. In this paper we argue that the opposite might be true --- traditional models might not be able to explain agent portfolio holdings because they do not explicitly account for the fact that human capital does trade (in the form of labor contracts). We derive wages endogenously as part of a dynamic equilibrium in a production economy. Risk is shared in labor markets because firms write bilateral labor contracts that insure workers, allowing agents to achieve a Pareto optimal allocation even when the span of asset markets is restricted to just stocks and bonds. Capital markets facilitate this risk sharing because it is there that firms offload the labor market risk they assumed from workers. In effect, by investing in capital markets investors provide insurance to wage earners who then optimally choose not to participate in capital markets. The model can produce some of the most important stylized facts in asset pricing: (1) limited asset market participation, (2) the seemingly high equity risk premium, (3) the very large disparity in the volatility of consumption and the volatility of asset prices, and (4) the time dependent correlation between consumption growth and asset returns.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15709.

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    Date of creation: Jan 2010
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    Handle: RePEc:nbr:nberwo:15709

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    1. Harrison Hong & Jeffrey D. Kubik & Jeremy C. Stein, 2001. "Social Interaction and Stock-Market Participation," NBER Working Papers 8358, National Bureau of Economic Research, Inc.
    2. Luigi Guiso & Michael Haliassos & Tullio Jappelli, 2002. "Household Stockholding in Europe: Where Do We Stand and Where Do We Go?," CSEF Working Papers, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy 88, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
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    15. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, Elsevier, vol. 15(2), pages 145-161, March.
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    19. Moscarini, Giuseppe & Thomsson, Kaj, 2006. "Occupational and Job Mobility in the US," Working Papers, Yale University, Department of Economics 19, Yale University, Department of Economics.
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    Cited by:
    1. Agrawal, Ashwini K. & Matsa, David A., 2013. "Labor unemployment risk and corporate financing decisions," Journal of Financial Economics, Elsevier, Elsevier, vol. 108(2), pages 449-470.
    2. Betermier, Sebastien & Jansson, Thomas & Parlour, Christine & Walden, Johan, 2012. "Hedging labor income risk," Journal of Financial Economics, Elsevier, Elsevier, vol. 105(3), pages 622-639.
    3. Betermier, Sebastien & Jansson, Thomas & Parlour, Christine A. & Walden, Johan, 2011. "Hedging Labor Income Risk," Working Paper Series 255, Sveriges Riksbank (Central Bank of Sweden).
    4. Paige Ouimet & Rebecca Zarutskie, 2011. "Acquiring Labor," Working Papers, Center for Economic Studies, U.S. Census Bureau 11-32, Center for Economic Studies, U.S. Census Bureau.

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