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

Gleb Kozliakov, Emile A. Marin and Sanjay Singh

No 377, Working Papers from University of California, Davis, Department of Economics

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 for an elasticity of intertemporal substitution of 0.2. In contrast, the consumption dynamics of high net-worth individuals predict a negative Sharpe ratio 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: 42
Date: 2026-03-12
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