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Equilibrium Asset Prices with Undiversifiable Labor Income Risk

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  • Weil, P.

Abstract

In a two-period Lucas tree economy in which ex ante identical, but ex post dissimilar, agents face undiversifiable labor income risk, calibrating a (wrong) representative agent model results in overstating the equilibrium riskfree rate and in understanding the equilibrium equity premium if the utility function exhibits decreasing absolute risk aversion and decreasing absolute prudence. These behavioral assumptions provide, as a consequence, a theoretical rationale for the often advanced conjecture that non-traded risk contributes to the solution of the riskfree rate and equity premium puzzles.
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Suggested Citation

  • Weil, P., 1991. "Equilibrium Asset Prices with Undiversifiable Labor Income Risk," Harvard Institute of Economic Research Working Papers 1564, Harvard - Institute of Economic Research.
    • Handle: RePEc:fth:harver:1564
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    References listed on IDEAS

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    1. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
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