Creator: Mehra, Rajnish and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 081 Abstract:
Restrictions that general equilibrium theory place upon average returns are found to be strongly violated by the U.S. data in the 1889–1978 period. This result is robust to model specification and measurement problems. We conclude that equilibrium models which are not Arrow-Debreu economies are needed to rationalize the large average equity premium that prevailed during the last 90 years.
Creator: Mehra, Rajnish, Piguillem, Facundo, and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 655 Abstract:
There is a large amount of intermediated borrowing and lending between households. Some of it is intergenerational, but most is between older households. The average difference in borrowing and lending rates is over 2 percent. In this paper, we develop a model economy that displays these facts and matches not only the returns on assets but also their quantities. The heterogeneity giving rise to borrowing and lending and differences in equity holdings depends on differences in the strength of the bequest motive. In equilibrium, the lenders are annuity holders and the borrowers are those who have equity holdings, who live off its income when retired, and who leave a bequest. The borrowing rate and return on equity are the same in the absence of aggregate uncertainty. The divergence between borrowing and lending rates can thus give rise to an equity premium, even in a world without aggregate uncertainty.
Keyword: Retirement, Equity premium, Government debt, Borrowing, Aggregate intermediation, Life cycle savings, and Lending Subject (JEL): H62 - National Deficit; Surplus, G23 - Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors, G11 - Portfolio Choice; Investment Decisions, D31 - Personal Income, Wealth, and Their Distributions, E21 - Macroeconomics: Consumption; Saving; Wealth, G12 - Asset Pricing; Trading Volume; Bond Interest Rates, E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data), E44 - Financial Markets and the Macroeconomy, H00 - Public Economics: General, and G10 - General Financial Markets: General (includes Measurement and Data)
Creator: Mehra, Rajnish, Piguillem, Facundo, and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 405 Abstract:
The difference between average borrowing and lending rates in the United States is over 2 percent. In spite of this large difference, there is over 1.7 times GNP in 2007 of intermediated borrowing and lending between households. In this paper a model is developed consistent with these facts. The only difference within an age cohort is preferences for bequests. Individuals with little or no bequest motive are lenders, while individuals with strong bequest motive are borrowers and owners of productive capital. Given no aggregate uncertainty, the return on equity is the same as the household borrowing rate. The government can borrow at the household lending rate, so there is a 2 percent equity premium in our world with no aggregate uncertainty. We examine the distribution and life cycle patterns of asset holding and consumption and find there is large dispersion in asset holdings and little in consumption.
This paper was subsequently published as Working Paper 685 under the title "Costly Financial Intermediation in Neoclassical Growth Theory."
Keyword: General equilibrium, Bequests, Life cycle, Asset returns, and Assets quantities Subject (JEL): G10 - General Financial Markets: General (includes Measurement and Data), E44 - Financial Markets and the Macroeconomy, and E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data)