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Equilibrium Asset Prices With Undiversifiable Labor Income Risk

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  • Philippe Weil

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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  • Philippe Weil, 1992. "Equilibrium Asset Prices With Undiversifiable Labor Income Risk," NBER Working Papers 3975, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3975
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    1. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, vol. 55(1), pages 143-154, January.
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