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Equilibrium Asset Prices With Undiversifiable Labor Income Risk

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Philippe Weil

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Abstract

In a two-period Lucas tree economy in which ex ante identical, but ex post dissimilar, agents face undiversifiable labor income risk, calibrating a (wrong) representative agent model results in overstating the equilibrium riskfree rate and in understanding the equilibrium equity premium if the utility function exhibits decreasing absolute risk aversion and decreasing absolute prudence. These behavioral assumptions provide, as a consequence, a theoretical rationale for the often advanced conjecture that non-traded risk contributes to the solution of the riskfree rate and equity premium puzzles.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3975.

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Date of creation: Jan 1992
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Handle: RePEc:nbr:nberwo:3975

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, vol. 49(4), pages 911-20, June. [Downloadable!] (restricted)
  2. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, vol. 55(1), pages 143-54, January. [Downloadable!] (restricted)
  3. Miles S. Kimball, 1991. "Standard Risk Aversion," NBER Technical Working Papers 0099, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January. [Downloadable!] (restricted)
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  5. Rouwenhorst, K.G., 1991. "Asset Returns and Business Cycles," Papers 40, Rochester, Business - Ph.D.,.
  6. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Aiyagari, S. Rao & Gertler, Mark, 1990. "Asset Returns With Transactions Costs And Uninsured Individual Risk: A Stage Iii Exercise," Working Papers 90-43, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
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  8. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-84, March. [Downloadable!] (restricted)
  9. 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. [Downloadable!] (restricted)
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  10. Kimball, M. & Weil, P., 1991. "Precautionary Savings and Consumption Smoothing Across Time and Possibilities," Harvard Institute of Economic Research Working Papers 1563, Harvard - Institute of Economic Research.
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