Can Models with Idiosyncratic Risk Solve the Equity Premium Puzzle? Redux

Gleb Kozliakov (), Emile Marin and Sanjay R. Singh
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Gleb Kozliakov: https://cepr.org/about/people/gleb-kozliakov

No 2026-06, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: Can idiosyncratic risk explain the equity premium? We revisit this question using a novel measure of imperfect risk sharing, implied by a large class of heterogeneous-agent models, constructed using household-level panel data. We identify a group of households – with relatively high income but low net worth – whose consumption is sufficiently volatile and risky to explain 94% of the observed U.S. Sharpe ratio. In contrast, the consumption dynamics of high net-worth individuals predict a negative Sharpe ratio and so do not constitute the relevant pricing factor, consistent with models featuring wealth motives.

Keywords: uninsurable idiosyncratic risk; heterogeneous agents; wealth dynamics; equity premium (search for similar items in EconPapers)
JEL-codes: B52 E21 G12 (search for similar items in EconPapers)
Pages: 43
Date: 2026-03-31
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DOI: 10.24148/wp2026-06

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