ASSET PRICING WITH UNDIVERSIFIABLE INCOME RISK AND SHORT SALES CONSTRAINTS - DEEPENING THE EQUITY PREMIUM PUZZLE

This paper studies asset prices and consumption patterns in an infinite horizon model with borrowing constraints and uninsurable idiosyncratic shocks to labor income. Calibration experiments demonstrate that idiosyncratic shocks to income are effectively smoothed through transactions in the securities market; consumption and asset prices are similar to those predicted in the representative agent model. This suggests that the equity premium puzzle is robust to several important sources of market incompleteness.