Borrowing Costs and the Demand for Equity over the Life Cycle

Steven J. Davis; Felix Kübler; Paul Willen

doi:10.1162/rest.88.2.348

Borrowing Costs and the Demand for Equity over the Life Cycle

Steven J. Davis; Felix Kübler; Paul Willen^1,2,3,4

¹ University of Mannheim · ² University of Chicago · ³ Federal Reserve Bank of Boston · ⁴ Federal Reserve Bank of Chicago

The Review of Economics and Statistics 2006

We construct a life cycle model that delivers realistic behavior for both equity holdings and borrowing. The key model ingredient is a wedge between the cost of borrowing and the risk-free investment return. Borrowing can either raise or lower equity demand, depending on the cost of borrowing. A borrowing rate equal to the expected return on equity—which we show roughly matches the data—minimizes the demand for equity. Alternative models with no borrowing or limited borrowing at the risk-free rate cannot simultaneously fit empirical evidence on borrowing and equity holdings.

DOI: 10.1162/rest.88.2.348
Volume: 88 (2)
Pages: 348-362
Language: en
Export: BibTeX
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