Kogan, Leonid, Makarov, Igor and Uppal, Raman (2007) The equity risk premium and the riskfree rate in an economy with borrowing constraints. Mathematics and Financial Economics, 1 (1). pp. 1-19. ISSN 1862-9679
Abstract
Our objective is to study analytically the effect of borrowing constraints on asset returns. We explicitly characterize the equilibrium for an exchange economy with two agents who differ in their risk aversion and are prohibited from borrowing. In a representative-agent economy with CRRA preferences, the Sharpe ratio of equity returns and the riskfree rate are linked by the risk aversion parameter. We show that allowing for preference heterogeneity and imposing borrowing constraints breaks this link. We find that an economy with borrowing constraints exhibits simultaneously a relatively high Sharpe ratio of stock returns and a relatively low riskfree interest rate, compared to both representative-agent and unconstrained heterogeneous-agent economies.
| Item Type: | Article |
|---|---|
| Official URL: | http://www.springer.com/mathematics/quantitative+f... |
| Additional Information: | © 2007 Springer |
| Divisions: | Finance |
| Subjects: | H Social Sciences > HB Economic Theory H Social Sciences > HG Finance |
| JEL classification: | D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D52 - Incomplete Markets G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates |
| Sets: | Departments > Finance Collections > Economists Online |
| Date Deposited: | 19 Aug 2013 07:50 |
| Last Modified: | 20 May 2019 00:54 |
| URI: | http://eprints.lse.ac.uk/id/eprint/51756 |
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