Seminar Papers, Institute for International Economic Studies, Stockholm University
Social Security and the Equity Premium Puzzle
Abstract: This paper shows that social security may be an important
factor in explaining the equity premium puzzle. In the absence of
shortselling constraints, the young shortsell bonds to the middle-aged and
buy equity. Social security reduces the bond demand of the middle-aged,
thereby restricting the possibilities of the young to finance their equity
purchases. They demand less equity and the return to equity goes up. Social
security also increases the covariance between future consumption and the
equity income of the young. The efect on the equity premium is substantial.
In fact, a model with social security and borrowing constraints can
generate a fairly realistic equity premium.
Keywords: Asset prices; the equity premium puzzle; social security; (follow links to similar papers)
JEL-Codes: G12; H55; (follow links to similar papers)
23 pages, March 16, 2004
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