Abstract

http://ssrn.com/abstract=352082
 
 

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Borrowing Costs and the Demand for Equity Over the Life Cycle


Steven J. Davis


University of Chicago; National Bureau of Economic Research (NBER)

Felix Kubler


University of Zurich; Swiss Finance Institute

Paul Willen


Federal Reserve Bank of Boston - Research Department; National Bureau of Economic Research (NBER)

November 2002

NBER Working Paper No. w9331

Abstract:     
We analyze consumption and portfolio behavior in a life-cycle model with realistic borrowing costs and income processes. We show that even a small wedge between borrowing costs and the risk-free return dramatically shrinks the demand for equity. When the cost of borrowing equals or exceeds the expected return on equity the relevant case according to the data households hold little or no equity during much of the life cycle. The model also implies that the correlation between consumption growth and equity returns is low at all ages, and that risk aversion estimates based on the standard excess return formulation of the consumption Euler Equation are greatly upward biased. The demand for equity in the model is non-monotonic in borrowing costs and risk aversion, and the standard deviation of marginal utility growth is an order of magnitude smaller than the Sharpe ratio.

Number of Pages in PDF File: 45

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Date posted: November 16, 2002  

Suggested Citation

Davis, Steven J. and Kubler, Felix and Willen, Paul, Borrowing Costs and the Demand for Equity Over the Life Cycle (November 2002). NBER Working Paper No. w9331. Available at SSRN: http://ssrn.com/abstract=352082

Contact Information

Steven J. Davis (Contact Author)
University of Chicago ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7312 (Phone)
773-702-0458 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Felix E. Kubler
University of Zurich ( email )
Rämistrasse 71
Zürich, CH-8006
Switzerland
Swiss Finance Institute ( email )
c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Paul Willen
Federal Reserve Bank of Boston - Research Department ( email )
600 Atlantic Avenue
Boston, MA 02210
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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