Market Incompleteness and the Equity Premium Puzzle: Evidence from State-Level Data

Journal of Banking & Finance, Vol. 37, No. 2, pp. 378-388, 2013

Posted: 15 Jan 2013

See all articles by Kris Jacobs

Kris Jacobs

University of Houston - C.T. Bauer College of Business

Stephane Pallage

University of Quebec at Montreal - Department of Economics; Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE)

Michel A. Robe

University of Illinois at Urbana-Champaign

Multiple version iconThere are 2 versions of this paper

Date Written: February 2013

Abstract

This paper investigates the importance of market incompleteness by comparing the rates of risk aversion estimated from complete and incomplete markets environments. For the incomplete-markets case, we use consumption data for the 50 US states. We find that the rate of risk aversion under the incomplete-markets setup is much lower. Furthermore, including the second and third moments of the cross-sectional distribution of consumption growth in the pricing kernel lowers the estimate of risk aversion. These findings suggest that market incompleteness ought to be seen as an important component of solutions to the equity premium puzzle.

Keywords: heterogeneity, idiosyncratic consumption risk, incomplete markets, consumption-based asset pricing model, risk aversion, equity premium puzzle

JEL Classification: G12

Suggested Citation

Jacobs, Kris and Pallage, Stephane and Robe, Michel A., Market Incompleteness and the Equity Premium Puzzle: Evidence from State-Level Data (February 2013). Journal of Banking & Finance, Vol. 37, No. 2, pp. 378-388, 2013, Available at SSRN: https://ssrn.com/abstract=2200302

Kris Jacobs (Contact Author)

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Stephane Pallage

University of Quebec at Montreal - Department of Economics ( email )

P.O. Box 8888, Downtown Station
Montreal, Quebec H3C 3P8
Canada
514-987-3000 ext. 8730 (Phone)
514-987-8494 (Fax)

Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE)

Pavillon De Sève
Ste-Foy, Quebec G1K 7P4
Canada

Michel A. Robe

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

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