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Asset Pricing with Limited Risk Sharing and Heterogeneous Agents

Francisco Gomes

London Business School

Alexander Michaelides

Imperial College Business School; Centre for Economic Policy Research (CEPR)


AFA 2006 Boston Meetings Paper

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.

Number of Pages in PDF File: 47

Keywords: Equity Premium, Preference Heterogeneity, Incomplete Risk Sharing, Life-Cycle Models, Limited Stock Market Participation.

JEL Classification: E21, G11

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Date posted: March 22, 2005  

Suggested Citation

Gomes, Francisco and Michaelides, Alexander, Asset Pricing with Limited Risk Sharing and Heterogeneous Agents (2005). AFA 2006 Boston Meetings Paper. Available at SSRN: http://ssrn.com/abstract=687126 or http://dx.doi.org/10.2139/ssrn.687126

Contact Information

Francisco Gomes (Contact Author)
London Business School ( email )
Institute of Finance and Accounting
Sussex Place - Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 7724 3317 (Fax)
HOME PAGE: http://www.london.edu/faculty/fgomes
Alexander Michaelides
Imperial College Business School ( email )
South Kensington Campus
Exhibition Road
London SW7 2AZ, DC SW7 2AZ
United Kingdom
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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References:  64
Citations:  45

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