Risks to Human Capital

77 Pages Posted: 5 Sep 2019 Last revised: 9 Mar 2020

See all articles by Mehran Ebrahimian

Mehran Ebrahimian

University of Pennsylvania - The Wharton School

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 8, 2020

Abstract

What is the connection between financing constraints and the equity premium? To answer this question, we build a model with inalienable human capital, in which investors finance individuals who can potentially become skilled. Though investment in skill is always optimal, it does not take place in some states of the world, due to moral hazard. In other states of the world, individuals acquire skill; however outside investors and individuals inefficiently share risk. We show that this simple moral hazard problem and the resultant financing friction leads to a realistic equity premium, a low riskfree rate, and severe negative consequences for distribution of wealth and for welfare.
When investment fails to take place, the economy enters an endogenous disaster state. We show that the possibility of these disaster states distorts risk prices, even under calibrations in which they never occur in equilibrium.

Keywords: Contracting Frictions, Rare Events, Moral Hazard

JEL Classification: G12, G32

Suggested Citation

Ebrahimian, Mehran and Wachter, Jessica A., Risks to Human Capital (March 8, 2020). Available at SSRN: https://ssrn.com/abstract=3443906 or http://dx.doi.org/10.2139/ssrn.3443906

Mehran Ebrahimian

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Jessica A. Wachter (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-7634 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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