An Equilibrium Model with Restricted Stock Market Participation
Rodney L. White Center Working Paper No. 1-97
Posted: 9 Apr 1997
This paper solves the equilibrium problem in a pure-exchange, continuous-time economy in which some agents face information costs or other types of frictions effectively preventing them from investing in the stock market. Under the assumption that the restricted agents have logarithmic utilities, the existence of an equilibrium is demonstrated, and a complete characterization of equilibrium prices and consumption/investment policies is provided. The restricted agents' consumption volatility is shown to be decreased in comparison to the benchmark economy in which all agents have free access to the stock market, while the unrestricted agents' consumption volatility is increased. The impact of restricted participation on equilibrium prices is also discussed. A simple calibration shows that the model can help resolve some of the empirical asset pricing puzzles. In the special case of both classes of agents having logarithmic preferences, it is shown that restricted participation unambiguously decreases the real interest rate and increases the stock risk premium, as compared to a benchmark economy with costless access to the stock market.
JEL Classification: D51, G12
Suggested Citation: Suggested Citation