Borrowing Costs and the Demand for Equity Over the Life Cycle

Steven Davis, Felix Kubler and Paul Willen

No 9331, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We analyze consumption and portfolio behavior in a life-cycle model with realistic borrowing costs and income processes. We show that even a small wedge between borrowing costs and the risk-free return dramatically shrinks the demand for equity. When the cost of borrowing equals or exceeds the expected return on equity the relevant case according to the data households hold little or no equity during much of the life cycle. The model also implies that the correlation between consumption growth and equity returns is low at all ages, and that risk aversion estimates based on the standard excess return formulation of the consumption Euler Equation are greatly upward biased. The demand for equity in the model is non-monotonic in borrowing costs and risk aversion, and the standard deviation of marginal utility growth is an order of magnitude smaller than the Sharpe ratio.

JEL-codes: D91 G11 (search for similar items in EconPapers)
Date: 2002-11
New Economics Papers: this item is included in nep-dge
Note: AP EFG
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Citations: View citations in EconPapers (7)

Published as Davis, Steven J., Felix Kubler and Paul Willen. "Borrowing Costs And The Demand For Equity Over The Life Cycle," Review of Economics and Statistics, 2006, v88(2,May), 348-362.

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Journal Article: Borrowing Costs and the Demand for Equity over the Life Cycle (2006)
Working Paper: Borrowing costs and the demand for equity over the life cycle (2005)
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