Risks to Human Capital

78 Pages Posted: 9 Mar 2020 Last revised: 16 Oct 2024

See all articles by Mehran Ebrahimian

Mehran Ebrahimian

Stockholm School of Economics - Finance Department

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER); Securities and Exchange Commission

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Date Written: March 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.

Suggested Citation

Ebrahimian, Mehran and Wachter, Jessica A., Risks to Human Capital (March 2020). NBER Working Paper No. w26823, Available at SSRN: https://ssrn.com/abstract=3550971

Mehran Ebrahimian (Contact Author)

Stockholm School of Economics - Finance Department ( email )

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Jessica A. Wachter

University of Pennsylvania - Finance Department ( email )

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