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Asset Pricing with Limited Risk Sharing and Heterogeneous AgentsFrancisco GomesLondon Business School Alexander MichaelidesUniversity of Cyprus - Department of Public and Business Administration; Centre for Economic Policy Research (CEPR) 2005 AFA 2006 Boston Meetings Paper Abstract: We solve a model with incomplete markets and heterogeneous agents that generates a large equity premium, while simultaneously matching individual allocations (stock market participation rate and asset holdings). Limited participation is derived endogenously and has a negligible impact on the risk premium, contrary to the results of models where it is imposed exogenously. We obtain a high risk premium with moderate risk aversion (5 or less). This is driven by incomplete risk sharing among stockholders, which results from the combination of borrowing constraints with a (realistically) calibrated life-cycle stochastic earnings profile subject to both aggregate and idiosyncratic shocks.
Keywords: Equity Premium, Preference Heterogeneity, Incomplete Risk Sharing, Life-Cycle Models, Limited Stock Market Participation. JEL Classification: E21, G11 working papers seriesDate posted: March 22, 2005Suggested CitationContact Information
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