Working Paper: NBER ID: w26823
Authors: Mehran Ebrahimian; Jessica Wachter
Abstract: What is the connection between financing constraints and the equity premium? To answer this question, we build a model with inalienable human capital, in which investors finance individuals who can potentially become skilled. Though investment in skill is always optimal, it does not take place in some states of the world, due to moral hazard. In other states of the world, individuals acquire skill; however outside investors and individuals inefficiently share risk. We show that this simple moral hazard problem and the resultant financing friction leads to a realistic equity premium, a low riskfree rate, and severe negative consequences for distribution of wealth and for welfare. When investment fails to take place, the economy enters an endogenous disaster state. We show that the possibility of these disaster states distorts risk prices, even under calibrations in which they never occur in equilibrium.
Keywords: No keywords provided
JEL Codes: G12; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financing constraints (G32) | inefficiencies in human capital investment (J24) |
| inefficiencies in human capital investment (J24) | equity premium (G12) |
| financing constraints (G32) | equity premium (G12) |
| moral hazard (G52) | financing constraints (G32) |
| endogenous disaster states (H84) | distort risk prices (G19) |
| distort risk prices (G19) | equity premium (G12) |