Borrowing Costs and the Demand for Equity Over the Life Cycle

45 Pages Posted: 16 Nov 2002 Last revised: 1 Jan 2023

See all articles by Steven J. Davis

Steven J. Davis

University of Chicago; National Bureau of Economic Research (NBER); Hoover Institution

Felix Kubler

University of Zurich; Swiss Finance Institute

Paul Willen

Federal Reserve Bank of Boston - Research Department; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: November 2002

Abstract

We analyze consumption and portfolio behavior in a life-cycle model with realistic borrowing costs and income processes. We show that even a small wedge between borrowing costs and the risk-free return dramatically shrinks the demand for equity. When the cost of borrowing equals or exceeds the expected return on equity the relevant case according to the data households hold little or no equity during much of the life cycle. The model also implies that the correlation between consumption growth and equity returns is low at all ages, and that risk aversion estimates based on the standard excess return formulation of the consumption Euler Equation are greatly upward biased. The demand for equity in the model is non-monotonic in borrowing costs and risk aversion, and the standard deviation of marginal utility growth is an order of magnitude smaller than the Sharpe ratio.

Suggested Citation

Davis, Steven J. and Kubler, Felix E. and Willen, Paul S., Borrowing Costs and the Demand for Equity Over the Life Cycle (November 2002). NBER Working Paper No. w9331, Available at SSRN: https://ssrn.com/abstract=352082

Steven J. Davis (Contact Author)

University of Chicago ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7312 (Phone)
773-702-0458 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Hoover Institution

434 Galvez Mall
Stanford University
Stanford, CA 94305-6010
United States
773 251 1795 (Phone)

Felix E. Kubler

University of Zurich ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Paul S. Willen

Federal Reserve Bank of Boston - Research Department ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
67
Abstract Views
1,568
Rank
154,417
PlumX Metrics