TY  - JOUR
AU  - Constantinidies,George M.
AU  - Donaldson,John B.
AU  - Mehra,Rajnish
TI  - Junior Can't Borrow:  A New Perspective on the Equity Premium Puzzle
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 6617
PY  - 1998
Y2  - June 1998
UR  - http://www.nber.org/papers/w6617
L1  - http://www.nber.org/papers/w6617.pdf
N1  - Author contact info:
George M. Constantinides
The University of Chicago
Booth School of Business
5807 South Woodlawn Avenue
Chicago, IL  60637
Tel: 773/702-7258
Fax: 773/753-8045
 (773) 753-8045
E-Mail: gmc@ChicagoBooth.edu

John B. Donaldson
Columbia Business School
3022 Broadway, Uris Hall
New York, NY 10027-6902
Tel: 212/854-3401
E-Mail: jd34@columbia.edu

Rajnish Mehra
Department of Economics
W. P. Carey School of Business
Arizona State University
PO Box 879801
Tempe, AZ  85287-9801
Tel: 480 965-6335
Fax: 480 965-0748
E-Mail: rajnish.mehra@asu.edu
AB  - Ongoing questions on the historical mean and standard deviation of the return on equities and bonds and on the equilibrium demand for these securities are addressed in the context of a stationary, overlapping-generations economy in which consumers are subject to a borrowing constraint.  The key feature captured by the OLG economy is that the bulk of the future income of the young agents is derived from their wages forthcoming in their middle age, while the bulk of the future income of the middle-aged agents is derived from their savings in equity and bonds. The young would like to borrow and invest in equity, but the borrowing constraint prevents them from doing so.  The middle-aged choose to hold a diversified portfolio that includes positive holdings of bonds, and this explains the demand for bonds.  Without the borrowing constraint, the young borrow and invest in equity, thereby decreasing the mean equity premium and increasing the rate of interest.
ER  -