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Borrowing Costs and the Demand for Equity over the Life Cycle

Steven Davis (), Felix Kubler () and Paul Willen

The Review of Economics and Statistics, 2006, vol. 88, issue 2, 348-362

Abstract: We construct a life cycle model that delivers realistic behavior for both equity holdings and borrowing. The key model ingredient is a wedge between the cost of borrowing and the risk-free investment return. Borrowing can either raise or lower equity demand, depending on the cost of borrowing. A borrowing rate equal to the expected return on equity-which we show roughly matches the data-minimizes the demand for equity. Alternative models with no borrowing or limited borrowing at the risk-free rate cannot simultaneously fit empirical evidence on borrowing and equity holdings. Copyright by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Date: 2006
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Working Paper: Borrowing costs and the demand for equity over the life cycle (2005) Downloads
Working Paper: Borrowing Costs and the Demand for Equity Over the Life Cycle (2002) Downloads
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