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Inequality, Stock Market Participation, and the Equity Premium

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  • Jack Favilukis


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    Over the last 25 years, labor income inequality has increased significantly; one may expect this would lead to significant increases in wealth and consumption inequality. However the increase in wealth inequality has been relatively moderate and consumption inequality has barely increased at all. At the same time, stock market participation has increased and the equity premium has declined. I solve a general equilibrium model to show that there is an intimate link between market participation and inequality. When wage inequality increases without a change to participation costs, the model predicts large increases in wealth and consumption inequality and a drop in market participation. However, if in addition, participation costs fall to match the increase in participation observed in the data, the model predicts changes in wealth and consumption inequality quantitatively similar to those observed in the data, as well as a large decline in the equity premium.

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    Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp602.

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    Date of creation: Nov 2007
    Handle: RePEc:fmg:fmgdps:dp602
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