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The Irrelevance of Market Incompleteness for the Price of Aggregate Risk

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  • Krueger, Dirk
  • Lustig, Hanno

Abstract

In models with a large number of agents who have constant relative risk aversion (CRRA) preferences, the absence of insurance markets for idiosyncratic labour income risk has no effect on the premium for aggregate risk if the distribution of idiosyncratic risk is independent of aggregate shocks. In spite of the missing markets, a representative agent who consumes aggregate income prices the excess returns on stocks correctly. This result holds regardless of the persistence of idiosyncratic shocks, as long as they are not permanent, even when households face binding, and potentially very tight borrowing constraints. Consequently, in this class of models there is no link between the extent of self-insurance against idiosyncratic income risk and aggregate risk premia.

Suggested Citation

  • Krueger, Dirk & Lustig, Hanno, 2006. "The Irrelevance of Market Incompleteness for the Price of Aggregate Risk," CEPR Discussion Papers 5936, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:5936
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    References listed on IDEAS

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    1. Yili Chien & Harold Cole & Hanno Lustig, 2011. "A Multiplier Approach to Understanding the Macro Implications of Household Finance," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 78(1), pages 199-234.

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    More about this item

    Keywords

    risk premium; Idiosyncratic income risk; Incomplete markets;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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