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Uninsurable Risk and Financial Market Puzzles

Basu, Parantap and Semenov, Andrei and Wada, Kenji (2009): Uninsurable Risk and Financial Market Puzzles.

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Abstract

Following Kocherlakota and Pistaferri (2009), we consider two forms of incomplete risk sharing in economies with consumer heterogeneity: (a) where agents are unable to insure their consumption against idiosyncratic skill shocks and (b) where idiosyncratic shocks to skills can be partially insured by striking long term insurance contract with truth revelation constraint. When considering the equity premium, currency premium, risk-free rate, and consumption-real exchange rate puzzles in an integrated framework, we find empirical evidence that although the pricing kernel associated with (a) outperforms the complete risk-sharing stochastic discount factor and the pricing kernel associated with (b), it is still unable to jointly resolve these asset-pricing anomalies.

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