Asset Pricing with Limited Risk Sharing and Heterogeneous Agents

Francisco Gomes; Alexander Michaelides

doi:10.1093/rfs/hhm063

Asset Pricing with Limited Risk Sharing and Heterogeneous Agents

Francisco Gomes^1,2,3; Alexander Michaelides^1,2,3

¹ University of North Carolina at Chapel Hill · ² London Business School · ³ London School of Economics and Political Science

Review of Financial Studies 2008 open access

1 We solve a model with incomplete markets and heterogeneous agents that generates a large equity premium, while simultaneously matching stock market participation and indi-vidual asset holdings. The high risk premium is driven by incomplete risk sharing among stockholders, which results from the combination of aggregate uncertainty, borrowing con-straints and a (realistically) calibrated life-cycle earnings profile subject to idiosyncratic shocks. We show that it is challenging to simultaneously match asset pricing moments and individual portfolio decisions, while limited participation has a negligible impact on the risk premium, contrary to the results of models where it is imposed exogenously. JEL Classification: G11, G12.

DOI: 10.1093/rfs/hhm063
Volume: 21 (1)
Pages: 415-448
Language: en
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