Journal Article

Asset Pricing with Limited Risk Sharing and Heterogeneous Agents

Francisco Gomes and Alexander Michaelides

in The Review of Financial Studies

Published on behalf of The Society for Financial Studies

Volume 21, issue 1, pages 415-448
Published in print January 2008 | ISSN: 0893-9454
Published online November 2007 | e-ISSN: 1465-7368 | DOI: https://dx.doi.org/10.1093/rfs/hhm063
Asset Pricing with Limited Risk Sharing and Heterogeneous Agents

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We develop a model with incomplete markets and heterogeneous agents that generates a large equity premium, while simultaneously matching stock market participation and individual asset holdings. The high risk-premium is driven by incomplete risk sharing among stockholders, which results from the combination of aggregate uncertainty, borrowing constraints, and a (realistically) calibrated life-cycle earnings profile subject to idiosyncratic shocks. We show that it is challenging to simultaneously match asset pricing moments and individual portfolio decisions, while limited participation has a negligible impact on the risk-premium, contrary to the results of models where it is imposed exogenously.

Keywords: G11; G12

Journal Article.  14905 words.  Illustrated.

Subjects: Economics

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