Asset Pricing with Heterogeneous Consumers and Limited Participation: Empirical Evidence
Alon P. Brav
Duke University - Fuqua School of Business
George M. Constantinides
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
University of Pennsylvania - The Wharton School, Finance Department
Journal of Political Economy, Forthcoming
We present evidence that the equity premium and the premium of value stocks over growth stocks are explained in the 1982-1996 period with a stochastic discount factor (SDF) calculated as the weighted average of individual households' marginal rate of substitution with low and economically plausible values of the relative risk aversion (RRA) coefficient. Household consumption of non-durables and services is reconstructed from the CEX database. Since the above premia are not explained with a SDF calculated as the per capita marginal rate of substitution with low value of the RRA coefficient, the evidence supports the hypothesis of incomplete consumption insurance. We also present evidence is that a SDF calculated as the per capita marginal rate of substitution is better able to explain the equity premium and does so with a lower value of the RRA coefficient, as the definition of asset holders is tightened to recognize the limited participation of households in the capital market.
Keywords: Equity premium, Incomplete consumption insurance, Heterogeneous consumers, Limited capital market participation
JEL Classification: G12, D91, E21Accepted Paper Series
Date posted: November 19, 2001
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