Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2014/5: Heterogeneity and limited stock market Participation

Knut K. Aase ()
Additional contact information
Knut K. Aase: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: We derive the equilibrium interest rate and risk premiums using recursive utility with heterogeneity in a continuous time model. We solve the associated sup-convolution problem, and obtain explicit closed form solutions. The heterogeneous two-agent model is calibrated to the data of Mehra and Prescott (1985) assuming the market portfolio is not a proxy of the wealth portfolio. This results in plausible values for the preference parameters of the two agents under various assumptions for the wealth portfolio.

Keywords: The equity premium puzzle; the risk-free rate puzzle; recursive utility; the stochastic maximum principle; heterogeneity; limited market participation

JEL-codes: D51; D53; D90; E21; G10; G12

36 pages, First version: February 28, 2014. Revised: March 25, 2015.

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