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Asset pricing with limited risk sharing and heterogeneous agents

  • Francisco Gomes
  • Alexander Michaelides

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://eprints.lse.ac.uk/24649/
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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 24649.

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Length: 47 pages
Date of creation: Mar 2005
Date of revision:
Handle: RePEc:ehl:lserod:24649
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