The stock market is driven by 'broke' people with high salaries, while the spending of the truly wealthy is actually a sign of bad returns.
Financial theory typically assumes that the wealthiest individuals, who own the most stock, are the ones whose behavior determines market risk premiums. This study finds the opposite: the spending of high-net-worth individuals doesn't match market logic at all, whereas a specific group of high-earners who haven't yet built wealth are the ones actually 'pricing' the market.
Can Models with Idiosyncratic Risk Solve the Equity Premium Puzzle? Redux *
SSRN · 6404738
Can idiosyncratic risk explain the equity premium? We revisit this question using a novel measure of imperfect risk sharing, implied by a large class of heterogeneous-agent models, constructed using household-level panel data. We identify a group of households-with relatively high income but low net-worth-whose consumption is sufficiently volatile and risky to explain 94% of the observed U.S. Sharpe ratio. In contrast, the consumption dynamics of high net-worth individuals predict a negative Sha