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Uninsurable Risk and Financial Market Puzzles

  • Parantap Basu
  • Andrei Semenovz
  • Kenji Wadax
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    This paper develops an integrated model, which addresses the recent Brandt, Cochrane and Santa-Clara (2006) puzzle of reconciling low international risk sharing with a high and variable equity premium. In addition, a new currency risk premium puzzle is also addressed. Following Kocherlakota and Pistaferri (2007), we examine two market structures: (i) where private risk cannot be insured and (ii) where the private risk can be partially insured by striking long term insurance contract with truth revelation constraint. Our GMM estimation based on the US-UK .nancial and cross-sectional household spending data lends support to the second market environment.

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    Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Conference Paper Series with number 0701.

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    Date of creation: Nov 2007
    Date of revision:
    Handle: RePEc:san:cdmacp:0701
    Contact details of provider: Postal: Department of Economics, University of St. Andrews, Fife KY16 9AL
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    1. Basu, Parantap & Wada, Kenji, 2006. "Is low international risk sharing consistent with a high equity premium? A reconciliation of two puzzles," Economics Letters, Elsevier, vol. 93(3), pages 436-442, December.
    2. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," NBER Working Papers 8896, National Bureau of Economic Research, Inc.
    3. David K. Backus & Gregor W. Smith, 1993. "Consumption and Real Exchange Rates in Dynamic Economies with Non-Traded Goods," Working Papers 1252, Queen's University, Department of Economics.
    4. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August.
    5. Bekaert, Geert & Hodrick, Robert J., 1993. "On biases in the measurement of foreign exchange risk premiums," Journal of International Money and Finance, Elsevier, vol. 12(2), pages 115-138, April.
    6. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    7. Tsyvinski, A. & Golosov, M., 2004. "Optimal Taxation with Endogenous Insurance Markets," 2004 Meeting Papers 124, Society for Economic Dynamics.
    8. Narayana R. Kocherlakota, 2003. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Levine's Bibliography 666156000000000426, UCLA Department of Economics.
    9. Alon Brav & George M. Constantinides & Christopher C. Geczy, 2002. "Asset Pricing with Heterogeneous Consumers and Limited Participation: Empirical Evidence," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 793-824, August.
    10. Kocherlakota, Narayana & Pistaferri, Luigi, 2005. "Asset Pricing Implications of Pareto Optimality with Private Information," CEPR Discussion Papers 4930, C.E.P.R. Discussion Papers.
    11. Brandt, Michael W. & Cochrane, John H. & Santa-Clara, Pedro, 2006. "International risk sharing is better than you think, or exchange rates are too smooth," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 671-698, May.
    12. Kocherlakota, Narayana & Pistaferri, Luigi, 2007. "Household Heterogeneity and Real Exchange Rates," CEPR Discussion Papers 6192, C.E.P.R. Discussion Papers.
    13. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
    14. Attanasio, Orazio P & Weber, Guglielmo, 1995. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1121-57, December.
    15. Tesar, Linda L. & Werner, Ingrid M., 1995. "Home bias and high turnover," Journal of International Money and Finance, Elsevier, vol. 14(4), pages 467-492, August.
    16. Geert Bekaert, 1994. "The Time Variation of Risk and Return in Foreign Exchange Markets: A General Equilibrium Perspective," NBER Working Papers 4818, National Bureau of Economic Research, Inc.
    17. Sergei Sarkissian, 2003. "Incomplete Consumption Risk Sharing and Currency Risk Premiums," Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 983-1005, July.
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