Overview

Existence of large left-tail shocks in the economy is crucial for the existence of equity premium and the observed equity volatility. While such shocks have occurred in the past, their cause, and hence their future distribution (along with their ability to explain the equity premium) remains a matter of debate. We present an asset pricing model with incomplete markets stemming from inalienable human capital. We show that inalienable human capital amplifies aggregate risk, leading to economic disasters that result in higher equity premia and higher volatility, as well as inefficient investment and negative distributional consequences.