We construct a life cycle model that delivers realistic behavior for both equity holdings and borrowing. The key model ingredient is a wedge between the cost of borrowing and the risk-free investment return. Borrowing can either raise or lower equity demand, depending on the cost of borrowing. A borrowing rate equal to the expected return on equity -which we show roughly matches the data - minimizes the demand for equity. Alternative models with no borrowing or limited borrowing at the risk-free rate cannot simultaneously fit empirical evidence on borrowing and equity holdings. © 2006 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
CITATION STYLE
Davis, S. J., Kubler, F., & Willen, P. (2006). Borrowing costs and the demand for equity over the life cycle. Review of Economics and Statistics, 88(2), 348–362. https://doi.org/10.1162/rest.88.2.348
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