DP5425 Distribution Risk and Equity Returns

Author(s): Jean-Pierre Danthine, John B Donaldson, Paolo Siconolfi
Publication Date: December 2005
Keyword(s): distribution risk, equity premium, income shares, limited market participation
JEL(s): E3, G1
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5425

In this paper we entertain the hypothesis that observed variations in income shares are the result of changes in the balance of power between workers and capital owners in labour relations. We show that this view implies that income share variations represent a risk factor of first-order importance for the owners of capital and, consequently, are a crucial determinant of the return to equity. When both risks are calibrated to observations, this distribution risk dominates in importance the usual systematic risk for the pricing of assets. We also show that distribution risks may originate in non-traded idiosyncratic income shocks.