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Asset Pricing with Limited Risk Sharing and Heterogeneous Agents

47 Pages Posted: 22 Mar 2005  

Francisco Gomes

London Business School

Alexander Michaelides

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Date Written: 2005

Abstract

We solve a model with incomplete markets and heterogeneous agents that generates a large equity premium, while simultaneously matching individual allocations (stock market participation rate and asset holdings). Limited participation is derived endogenously and has a negligible impact on the risk premium, contrary to the results of models where it is imposed exogenously. We obtain a high risk premium with moderate risk aversion (5 or less). This is driven by incomplete risk sharing among stockholders, which results from the combination of borrowing constraints with a (realistically) calibrated life-cycle stochastic earnings profile subject to both aggregate and idiosyncratic shocks.

Keywords: Equity Premium, Preference Heterogeneity, Incomplete Risk Sharing, Life-Cycle Models, Limited Stock Market Participation.

JEL Classification: E21, G11

Suggested Citation

Gomes, Francisco and Michaelides, Alexander, Asset Pricing with Limited Risk Sharing and Heterogeneous Agents (2005). AFA 2006 Boston Meetings Paper. Available at SSRN: https://ssrn.com/abstract=687126 or http://dx.doi.org/10.2139/ssrn.687126

Francisco Gomes (Contact Author)

London Business School ( email )

Institute of Finance and Accounting
Sussex Place - Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 7724 3317 (Fax)

HOME PAGE: http://www.london.edu/faculty/fgomes

Alexander Michaelides

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

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