Uninsured Risks, Loan Contracts and the Declining Equity Premium

Sanjay Banerjee and Parantap Basu

CDMA Conference Paper Series from Centre for Dynamic Macroeconomic Analysis

Abstract: Using a two period model with moral hazard and uninsured risk, we argue that the decline in equity premium from its historically high level is due to a gradual elimination of barriers to universal banking. The loan contracts set up by financial intermediaries became more complete in nature with the advent of universal banking in the 90s following the Gramm-Leach-Billy Act. Hence, it is the nature of the loan contracts, not just the borrowing constraint and uninsured risks that is more fundamental in explaining the size of the equity premium.

Date: 2005-08
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