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The Equity Premium in a DSGE Model with Limited Asset Market Participation

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  • Lorenzo Menna
  • Patrizio Tirelli

Abstract

Models based on the representative agent assumption cannot rationalize observed equity premia. In response to this, exchange economy models have introduced agents heterogeneity, typically in the form of bond and equity holders. We reconsider the issue introducing Limited Asset Market Participation in an otherwise standard medium scale DSGE model. Our model fits financial and macroeconomic data well. We obtain that the correlation between asset holders consumption and financial returns strongly increases in the share of agents excluded from financial markets participation, The predicted unconditional equity premium is therefore large. Further, the strong correlation between dividends and Ricardian households' consumption unambiguously increases precautionary savings and reduces the riskless rate.

Suggested Citation

  • Lorenzo Menna & Patrizio Tirelli, 2014. "The Equity Premium in a DSGE Model with Limited Asset Market Participation," Working Papers 275, University of Milano-Bicocca, Department of Economics, revised Jun 2014.
  • Handle: RePEc:mib:wpaper:275
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    File URL: http://dems.unimib.it/repec/pdf/mibwpaper275.pdf
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    References listed on IDEAS

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    Cited by:

    1. Albonico, Alice & Paccagnini, Alessia & Tirelli, Patrizio, 2016. "In search of the Euro area fiscal stance," Journal of Empirical Finance, Elsevier, vol. 39(PB), pages 254-264.
    2. repec:eee:dyncon:v:81:y:2017:i:c:p:140-161 is not listed on IDEAS
    3. Alice Albonico & Alessia Paccagnini & Patrizio Tirelli, 2014. "Estimating a DSGE model with Limited Asset Market Participation for the Euro Area," Working Papers 286, University of Milano-Bicocca, Department of Economics, revised Nov 2014.
    4. Albonico, Alice & Paccagnini, Alessia & Tirelli, Patrizio, 2017. "Great recession, slow recovery and muted fiscal policies in the US," Journal of Economic Dynamics and Control, Elsevier, vol. 81(C), pages 140-161.

    More about this item

    Keywords

    asset pricing; equity premium; limited asset market participation; business cycle; DSGE; sticky 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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