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The equity premium and the allocation of income risk

Author

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  • Jean-Pierre Danthine
  • John B. Donaldson
  • Rajnish Mehra

Abstract

This paper examines the extent to which the equity premium puzzle can be resolved by taking account of the fact that stockholders bear a disproportionate share of output uncertainty. We do this in the context of a non-Walrasian RBC model where risk reallocation is justified by borrowing restrictions. The risk shifting mechanism we propose has the same effect as would arise from a substantial increase in the risk aversion parameter of the representative agent. As with more standard RBC models, it remains that our model is unable to replicate key financial statistics. In particular, the observation that the equity return is more variable than national product cannot be accounted for under standard technology assumptions.

Suggested Citation

  • Jean-Pierre Danthine & John B. Donaldson & Rajnish Mehra, 1992. "The equity premium and the allocation of income risk," Discussion Paper / Institute for Empirical Macroeconomics 60, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmem:60
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    References listed on IDEAS

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    1. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 11-44, January.
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    More about this item

    Keywords

    Risk; Stock - Prices;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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