Junior is rich: bequests as consumption

We explore the consequences for asset pricing of admitting a bequest motive into an otherwise standard overlapping generations economy where agents trade equity, a risk free asset and consol bonds. With low risk aversion, the calibrated model produces realistic values for the mean equity premium and the risk free rate, the variance of the equity premium, and the ratio of bequests to wealth. However, the variance of the risk free rate is unrealistically high. Security prices tend to be substantially higher in an economy with bequests as compared to an otherwise identical one where bequests are absent. We are able to keep the prices sufficiently low to generate reasonable returns and premia by stipulating that a portion of the bequests skips a generation and is received by the young.

“You never actually own a Patek Philippe. You merely take care of it for the next generation.” Patek Philippe & Co.

We thank John Cox, Jean Pierre Danthine, Felix Kubler, Edward Prescott and seminar participants at The Bank of Italy, Columbia, Lausanne, Mannheim, MIT, Lugano, SIFR, the University of New South Wales, USC, Yale and the University of Zurich for insightful xcomments. The usual caveat applies.