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Asset pricing with limited risk sharing and heterogeneous agents

  • Francisco Gomes
  • Alexander Michaelides
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    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/
    File Function: Open access version.
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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
    Contact details of provider: Postal: LSE Library Portugal Street London, WC2A 2HD, U.K.
    Phone: +44 (020) 7405 7686
    Web page: http://www.lse.ac.uk/

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