Market incompleteness and the equity premium puzzle: Evidence from state-level data

Kris Jacobs; Stéphane Pallage; Michel A. Robe

doi:10.1016/j.jbankfin.2012.09.005

Market incompleteness and the equity premium puzzle: Evidence from state-level data

Kris Jacobs
, Stéphane Pallage
, Michel A. Robe

Research output: Contribution to journal › Article › peer-review

Abstract

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.

Original language	English (US)
Pages (from-to)	378-388
Number of pages	11
Journal	Journal of Banking and Finance
Volume	37
Issue number	2
DOIs	https://doi.org/10.1016/j.jbankfin.2012.09.005
State	Published - Feb 2013
Externally published	Yes

Keywords

Consumption-based asset pricing model
Equity premium puzzle
Heterogeneity
Idiosyncratic consumption risk
Incomplete markets
Risk aversion

ASJC Scopus subject areas

Finance
Economics and Econometrics

Online availability

10.1016/j.jbankfin.2012.09.005

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title = "Market incompleteness and the equity premium puzzle: Evidence from state-level data",

abstract = "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.",

keywords = "Consumption-based asset pricing model, Equity premium puzzle, Heterogeneity, Idiosyncratic consumption risk, Incomplete markets, Risk aversion",

author = "Kris Jacobs and St{\'e}phane Pallage and Robe, \{Michel A.\}",

note = "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{\textquoteright}s research was financially supported by FCAR/FQRSC; Robe{\textquoteright}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.",

year = "2013",

month = feb,

doi = "10.1016/j.jbankfin.2012.09.005",

language = "English (US)",

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Market incompleteness and the equity premium puzzle: Evidence from state-level data

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Keywords

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