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

Listed author(s):
  • Lorenzo Menna
  • Patrizio Tirelli

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.

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File URL: http://dems.unimib.it/repec/pdf/mibwpaper275.pdf
File Function: First version, 2014
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Paper provided by University of Milano-Bicocca, Department of Economics in its series Working Papers with number 275.

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Length: 30
Date of creation: Jun 2014
Date of revision: Jun 2014
Handle: RePEc:mib:wpaper:275
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