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Endogenous Labor/Leisure/Investment Choice under Time Constraints

Published online by Cambridge University Press:  08 April 2011

Dong-Hyun Ahn  and
Sun-Joong Yoon
Dong-Hyun Ahn
Affiliation:
School of Economics, Seoul National University, Gwanangno 599, Gwanak-gu, Seoul, Korea, [email protected]
Sun-Joong Yoon
Affiliation:
College of Business, Hallym University, Hallymdaehak-gil 1, Chuncheon, Kangwon-Do 200-702, Korea, [email protected]
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Abstract

We posit the opportunity cost of time required to manage risky investments, including conducting research and performance monitoring, as a potential explanation for the equity premium puzzle. An economic agent, who should allocate a limited amount of time to labor, leisure, and risky investment, is subject to the opportunity time cost of investment activity, which is foregone labor or leisure. Our model envisages its impact on equity premium and volatility in the presence of such a time constraint, in particular, with closed-form solutions to the risky asset returns, volatility, and risk-free rate in a simple equilibrium framework wherein agents have log utility. The model is shown to yield excess return and volatility consistent with historical values observed in the U.S. stock market, even with a small amount of time cost. In addition, the model enables us to sort out the impact of endogenous labor/leisure choice on return dynamics by comparing it with the exogenous labor income case.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 4 , August 2011 , pp. 1157 - 1192
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

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