TY - JOUR
T1 - Market incompleteness and the equity premium puzzle
T2 - Evidence from state-level data
AU - Jacobs, Kris
AU - Pallage, Stéphane
AU - Robe, Michel A.
N1 - Funding Information:
We are grateful to an anonymous referee for insightful suggestions. We also thank Pat Fishe, Steve Heston, Albert Marcet, Sergei Sarkissian, Chris Telmer and seminar participants at the Federal Reserve Board, the University of Maryland, George Washington University, George Mason University, and a meeting of the European Economic Association in Amsterdam for helpful comments. We thank the publishers of Sales and Marketing Management (SMM) for permission to use their state-level retail sales data, and are very grateful to Marco del Negro for his help with the SMM and state-level CPI data. Jacobs would like to acknowledge FQRSC, SSHRC and IFM2 for financial support. Pallage’s research was financially supported by FCAR/FQRSC; Robe’s, by a Kogod endowed fellowship. This paper was revised in part while Robe was a visiting Senior Economist at the US Commodity Futures Trading Commission (CFTC). The views expressed in this paper are those of the authors only and do not reflect the views or opinions of the CFTC, the Commissioners, or other CFTC staff. The authors are responsible for all errors and omissions, if any.
PY - 2013/2
Y1 - 2013/2
N2 - This paper investigates the importance of market incompleteness by comparing the rates of risk aversion estimated from complete and incomplete markets environments. For the incomplete-markets case, we use consumption data for the 50 US states. We find that the rate of risk aversion under the incomplete-markets setup is much lower. Furthermore, including the second and third moments of the cross-sectional distribution of consumption growth in the pricing kernel lowers the estimate of risk aversion. These findings suggest that market incompleteness ought to be seen as an important component of solutions to the equity premium puzzle.
AB - This paper investigates the importance of market incompleteness by comparing the rates of risk aversion estimated from complete and incomplete markets environments. For the incomplete-markets case, we use consumption data for the 50 US states. We find that the rate of risk aversion under the incomplete-markets setup is much lower. Furthermore, including the second and third moments of the cross-sectional distribution of consumption growth in the pricing kernel lowers the estimate of risk aversion. These findings suggest that market incompleteness ought to be seen as an important component of solutions to the equity premium puzzle.
KW - Consumption-based asset pricing model
KW - Equity premium puzzle
KW - Heterogeneity
KW - Idiosyncratic consumption risk
KW - Incomplete markets
KW - Risk aversion
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U2 - 10.1016/j.jbankfin.2012.09.005
DO - 10.1016/j.jbankfin.2012.09.005
M3 - Article
AN - SCOPUS:84869884312
SN - 0378-4266
VL - 37
SP - 378
EP - 388
JO - Journal of Banking and Finance
JF - Journal of Banking and Finance
IS - 2
ER -