Asset Pricing: Models and Empirical Evidence

Young people would like to invest in equities, given the observed high equity premium. However, they are reluctant to reduce their current consumption in order to save by investing in stocks, because the bulk of their lifetime income comes from their wages in their middle age. They want to borrow ag...

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Bibliographic Details
Published in:The Journal of political economy 2017-12, Vol.125 (6), p.1782-1790
Main Author: Constantinides, George M.
Format: Article
Language:English
Subjects:
and of Chicago Economics
Asset pricing
Consumers
Consumption
Economic theory
Equity
Human capital
Loans
Middle age
Moral hazard
Ownership
Political economy
Risk assessment
Savings
Securities markets
Time series
Wages & salaries
Youth
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Summary:Young people would like to invest in equities, given the observed high equity premium. However, they are reluctant to reduce their current consumption in order to save by investing in stocks, because the bulk of their lifetime income comes from their wages in their middle age. They want to borrow against their future income, but the borrowing constraints prevent them from doing so. Human capital alone cannot be used as collateral for large loans in modern economies for reasons of moral hazard and adverse selection. The model explains why many consumers do not participate in the stock market when they are young. Middle-aged consumers earn income that they partly consume and partly save by purchasing equities and bonds. The old earn no income and consume their savings. Therefore, the risk of stock and bond ownership is concentrated in the hands of middle-aged consumers who save. This concentration of risk generates the high equity premium and the demand for bonds, in addition to the demand for shares by the middle-aged. The model acknowledges and addresses at the same time the issue of the limited participation in the stock market and the demand for bonds. [web URL: http://www.journals.uchicago.edu/doi/full/10.1086/694621]
ISSN:0022-3808
1537-534X
DOI:10.1086/694621