Asset Pricing with Limited Risk Sharing and Heterogeneous Agents

53 Pages Posted: 19 May 2008

See all articles by Francisco Gomes

Francisco Gomes

London Business School

Alexander Michaelides

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

Multiple version iconThere are 2 versions of this paper

Date Written: February 2007

Abstract

We solve 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: Equity premium, incomplete risk sharing, life-cycle models, limited stock market participation, preference heterogeneity

JEL Classification: G11, G12

Suggested Citation

Gomes, Francisco and Michaelides, Alexander, Asset Pricing with Limited Risk Sharing and Heterogeneous Agents (February 2007). CEPR Discussion Paper No. DP6136. Available at SSRN: https://ssrn.com/abstract=1133781

Francisco Gomes (Contact Author)

London Business School ( email )

Institute of Finance and Accounting
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London NW1 4SA
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+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, SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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