Asset Pricing with Limited Risk Sharing and Heterogeneous Agents,” The Review of Financial Studies

We solve a model with incomplete markets and heterogeneous agents that generates a large equity premium, while simultaneously matching stock market participation and indi-vidual asset holdings. The high risk premium is driven by incomplete risk sharing among stockholders, which results from the combination of borrowing constraints and (realistically) calibrated life-cycle earnings profiles, subject to both aggregate and idiosyncratic shocks. We show that it is challenging to simultaneously match aggregate quantities (asset prices) and individual quantities (asset allocations). Furthermore, limited participation has a neg-ligible impact on the risk premium, contrary to the results of models where it is imposed exogenously. JEL Classification: E21, G11