Limited Capital Market Participation and Human Capital Risk

33 Pages Posted: 1 Feb 2010 Last revised: 23 Mar 2010

See all articles by Jonathan Berk

Jonathan Berk

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Johan Walden

University of Lausanne; Swiss Finance Institute; University of California, Berkeley - Finance Group

Date Written: January 2010

Abstract

The non-tradability of human capital is often cited for the failure of traditional asset pricing theory to explain agents' portfolio holdings. In this paper we argue that the opposite might be true --- traditional models might not be able to explain agent portfolio holdings because they do not explicitly account for the fact that human capital does trade (in the form of labor contracts). We derive wages endogenously as part of a dynamic equilibrium in a production economy. Risk is shared in labor markets because firms write bilateral labor contracts that insure workers, allowing agents to achieve a Pareto optimal allocation even when the span of asset markets is restricted to just stocks and bonds. Capital markets facilitate this risk sharing because it is there that firms offload the labor market risk they assumed from workers. In effect, by investing in capital markets investors provide insurance to wage earners who then optimally choose not to participate in capital markets. The model can produce some of the most important stylized facts in asset pricing: (1) limited asset market participation, (2) the seemingly high equity risk premium, (3) the very large disparity in the volatility of consumption and the volatility of asset prices, and (4) the time dependent correlation between consumption growth and asset returns.

Suggested Citation

Berk, Jonathan B. and Walden, Johan, Limited Capital Market Participation and Human Capital Risk (January 2010). NBER Working Paper No. w15709, Available at SSRN: https://ssrn.com/abstract=1544759

Jonathan B. Berk (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Johan Walden

University of Lausanne

Quartier Chambronne
Lausanne, Vaud CH-1015
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

University of California, Berkeley - Finance Group ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
(510) 643-0547 (Phone)

HOME PAGE: http://www.haas.berkeley.edu/faculty/walden.html

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
34
Abstract Views
688
PlumX Metrics