Limited stock market participation and asset prices in a dynamic economy
Hui Guo ()
No 2000-031, Working Papers from Federal Reserve Bank of St. Louis
We present a consumption-based model that explains the equity premium puzzle through two channels. First, because of borrowing constraints, the shareholder cannot completely diversify his income risk and requires a sizable risk premium on stocks. Second, because of limited stock market participation, the precautionary saving demand lowers the risk-free rate but not stock return and generates a substantial liquidity premium. Our model also replicates many other salient features of the data, including the first two moments of the risk-free rate, excess stock volatility, stock return predictability, and the unstable relation between stock volatility and the dividend yield.
Keywords: Stock - Prices; Stock market; Asset pricing (search for similar items in EconPapers)
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Published in Journal of Financial and Quantitative Analysis, September 2004, 39(3), pp. 495-516
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Journal Article: Limited Stock Market Participation and Asset Prices in a Dynamic Economy (2004)
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