Journal Article

Explaining financial market facts: the importance of incomplete markets and transaction costs

Abstract: In this article, I suggest that incomplete markets and transaction costs are crucial for explaining the high equity premium and the low risk-free rate. I first demonstrate the failure of the complete frictionless markets model in explaining these return puzzles and then show how introducing incomplete markets and transaction costs can lead to success. Additionally, I explain how these features lead to predictions concerning individual consumptions, wealths, portfolios, and asset market transactions that are in better agreement with the facts than the predictions of the complete frictionless markets model.

Keywords: Interest rates;

Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Quarterly Review

Publication Date: 1993

Volume: 17

Issue: Win

Pages: 17-31