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Equilibrium Asset Prices with Undiversifiable Labor Income Risk

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  • Philippe Weil

    (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)

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.

Suggested Citation

  • Philippe Weil, 1992. "Equilibrium Asset Prices with Undiversifiable Labor Income Risk," SciencePo Working papers Main hal-03399140, HAL.
    • Handle: RePEc:hal:spmain:hal-03399140
    Note: View the original document on HAL open archive server: https://hal-sciencespo.archives-ouvertes.fr/hal-03399140
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    References listed on IDEAS

    as
    1. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
    2. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
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    12. Aiyagari, S. Rao & Gertler, Mark, 1991. "Asset returns with transactions costs and uninsured individual risk," Journal of Monetary Economics, Elsevier, vol. 27(3), pages 311-331, June.
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