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Equilibrium Asset Prices With Undiversifiable Labor Income Risk

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  • Philippe Weil

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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Bibliographic Info

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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Publication status: published as Journal of Economic Dynamics and Control, Vol. 16, nos. 3/4 (1992): 769-790 .
Handle: RePEc:nbr:nberwo:3975

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  1. S Rao Aiyagari & Mark Gertler, 1997. "Asset Returns with transaction costs and uninsured individual risk," Levine's Working Paper Archive 648, David K. Levine.
  2. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  3. S. Rao Aiyagari & Mark Gertler, 1990. "Asset Returns with Transactions Cost and Uninsured Risk: A Stage III Exercise," NBER Working Papers 3481, National Bureau of Economic Research, Inc.
  4. Miles Kimball & Philippe Weil, 2009. "Precautionary Saving and Consumption Smoothing across Time and Possibilities," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(2-3), pages 245-284, 03.
  5. Rouwenhorst, K.G., 1991. "Asset Returns and Business Cycles," Papers 40, Rochester, Business - Ph.D.,.
  6. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, vol. 55(1), pages 143-54, January.
  7. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  8. 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.
  9. 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.
  10. Miles S. Kimball, 1991. "Standard Risk Aversion," NBER Technical Working Papers 0099, National Bureau of Economic Research, Inc.
  11. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, vol. 49(4), pages 911-20, June.
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