Limited Capital Market Participation and Human Capital Risk

Jonathan Berk and Johan Walden

No 15709, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The non-tradability of human capital is often cited for the failure of traditional asset pricing theory to explain agents' portfolio holdings. In this paper we argue that the opposite might be true --- traditional models might not be able to explain agent portfolio holdings because they do not explicitly account for the fact that human capital does trade (in the form of labor contracts). We derive wages endogenously as part of a dynamic equilibrium in a production economy. Risk is shared in labor markets because firms write bilateral labor contracts that insure workers, allowing agents to achieve a Pareto optimal allocation even when the span of asset markets is restricted to just stocks and bonds. Capital markets facilitate this risk sharing because it is there that firms offload the labor market risk they assumed from workers. In effect, by investing in capital markets investors provide insurance to wage earners who then optimally choose not to participate in capital markets. The model can produce some of the most important stylized facts in asset pricing: (1) limited asset market participation, (2) the seemingly high equity risk premium, (3) the very large disparity in the volatility of consumption and the volatility of asset prices, and (4) the time dependent correlation between consumption growth and asset returns.

JEL-codes: G11 G12 J24 (search for similar items in EconPapers)
Date: 2010-01
New Economics Papers: this item is included in nep-bec, nep-dge, nep-hrm and nep-lab
Note: AP
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Citations: View citations in EconPapers (5)

Published as Jonathan B. Berk & Johan Walden, 2013. "Limited Capital Market Participation and Human Capital Risk," Review of Asset Pricing Studies, vol 3(1), pages 1-37.

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