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Federal Reserve Bank of Boston
Working Papers
Borrowing costs and the demand for equity over the life cycle
Steven J. Davis
Felix Kubler
Paul S. Willen
Abstract

We construct a life-cycle model that delivers realistic behavior for both equity holdings and borrowings. 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.


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Steven J. Davis & Felix Kubler & Paul S. Willen, Borrowing costs and the demand for equity over the life cycle, Federal Reserve Bank of Boston, Working Papers 05-7, 2005.
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Keywords: Households - Economic aspects ; Investments
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