CHAPTER 13 Can Heterogeneity, Undiversified Risk, and Trading Frictions Solve the Equity Premium Puzzle?

John Heaton

University of Chicago and NBER

Deborah Lucas

Northwestern University and NBER

1. Introduction

2. Labor Income as Background Risk

3. Entrepreneurial Income as Background Risk

4. Limited Participation and Limited Diversification

5. Conclusions

Abstract Can the historical equity premium be explained as a rational equilibrium outcome when risk-averse agents with conventional preferences are faced with non-diversifiable sources of risk (e.g., from labor or entrepreneurial income), and when trading frictions prevent them from using financial assets to ...

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