Pricing Risk in Economies with Heterogenous Agents and Incomplete Markets

Josep Pijoan-Mas

No 5602, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Habit formation has been proposed as a possible solution to the equity premium puzzle. This paper extends the class of models that support the habits explanation in order to account for heterogeneity in earnings, wealth, habits and consumption. I find that habit formation does indeed increase the equity premium. However, contrary to earlier results, the habit hypothesis does not imply a price for risk as big as the one measured in the data. There are three reasons for this. First, households in a habits economy modify their consumption/savings decision. Second, they modify their portfolio choice. These two changes in behavior diminish the consumption fluctuations faced by households. And third, the composition of the set of agents pricing risk in the economy changes so that relatively better self-insured households end up pricing risk.

Keywords: Equity premium; Habit formation; Incomplete markets (search for similar items in EconPapers)
JEL-codes: C68 D52 E21 G12 (search for similar items in EconPapers)
Date: 2006-03
New Economics Papers: this item is included in nep-dge, nep-fin, nep-fmk and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

Downloads: (external link)
https://cepr.org/publications/DP5602 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Working Paper: Pricing Risk in Economies with Heterogenous Agents and Incomplete Markets (2003)
Working Paper: Pricing Risk in Economies with Heterogenous Agents and Incomplete Markets (2002)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:5602

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP5602

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().