The equity premium in an overlapping-generations economy |
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| Institution: | 1. Department of Applied Economics, Department of Finance, National Chung Hsing University, Taiwan;2. Department of Finance and Banking, National Pingtung Institute of Commerce, Taiwan;3. Department of Quantitative Finance, National Tsing Hua University, Hsinchu, Taiwan;4. Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam, The Netherlands;5. Tinbergen Institute, The Netherlands;6. Department of Quantitative Economics, Complutense University of Madrid, Spain;1. Department of Finance, National University of Kaohsiung, Taiwan;2. Department of Real Estate & Built Environment, National Taipei University, Taiwan;1. International Service Economic Research Institute, Guangdong University of Foreign Studies, Guangzhou, PR China;2. Wenlan School of Business, Zhongnan University of Economics and Law, Wuhan, PR China;3. Institute of Industrial Economics, Jinan University, Guangzhou, PR China |
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| Abstract: | In a recent paper, Constantinides, Donaldson and Mehra (CDM) present a convincing economic story that could simultaneously explain a high equity premium and a low risk-free rate. The argument is based on the effect of a borrowing restriction in an overlapping-generations model (OLG) with three generations. This paper investigates the effect of borrowing restrictions on the size of the equity premium in a model similar to CDM, but with a complete structure of contingent claims. The main conclusion of the analysis is that the results obtained by CDM follow from the particular market structure adopted in the model rather than the effects of the life cycle. Once the markets are completed, the equity premium and the risk-free rate in the OLG economy are identical to those obtained in a representative-agent (RA) economy. |
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