Wealth Inequality, Stock Market Participation, and the Equity Premium

56 Pages Posted: 5 Nov 2012  

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance

Date Written: April 30, 2012

Abstract

The last 30 years saw substantial increases in wealth inequality and in stock market participation, smaller increases in consumption inequality and the fraction of indebted households, a decline in interest rates and in the expected equity premium, as well as a prolonged stock market boom. Understanding the causes of these trends is crucial for many questions in finance and economics. In an incomplete markets, overlapping generations model we show that these trends can be jointly explained by the observed rise in wage inequality, as well as a decrease in participation costs and a loosening of borrowing constraints. Once we account for these changes, we show that the observed pattern of stock prices played a major role in increasing wealth inequality because stockholders, who tend to be wealthy, benefit most from a bull market. Crucially, these phenomena must be considered jointly; studying one independently leads to counterfactual predictions about others. For example, a loosening of credit standards is expected to raise, rather than lower interest rates through decreased precautionary savings as well as vastly increase the fraction of households in debt; an increase in labor inequality is (somewhat counterintuitively) expected to lower rather than raise wealth inequality, again through precautionary savings; increased stock market participation should also lower wealth inequality.

Keywords: Inequality, Limited Participation, Equity Premium

JEL Classification: E21, E44, G12

Suggested Citation

Favilukis, Jack Y, Wealth Inequality, Stock Market Participation, and the Equity Premium (April 30, 2012). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2171359

Jack Y Favilukis (Contact Author)

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

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