Heterogeneity of First-order Risk Aversion and the Equity Premium

I show that stockholders and non-stockholders can coexist in equilibrium even if securities markets are perfect and complete. This is due to a heterogeneous safety inclination, which is defined as heterogeneity in first-order risk aversion (Segal and Spivak, 1990). A static two-security market model is analysed by the mean–standard deviation approach, where safety inclination is described by the degree of the marginal rate of substitution between the mean and the standard deviation at a certain point. In equilibrium, aggregate shocks may be concentrated on stockholders, which may lead to a high equity premium.
JEL Classification Numbers: D81, E44.