The Wharton School
University of Pennsylvania
3620 Locust Walk
NBER Working Papers and Publications
|March 2020||Risks to Human Capital|
with Jessica Wachter: w26823
What is the connection between financing constraints and the equity premium? To answer this question, we build a model with inalienable human capital, in which investors finance individuals who can potentially become skilled. Though investment in skill is always optimal, it does not take place in some states of the world, due to moral hazard. In other states of the world, individuals acquire skill; however outside investors and individuals inefficiently share risk. We show that this simple moral hazard problem and the resultant financing friction leads to a realistic equity premium, a low riskfree rate, and severe negative consequences for distribution of wealth and for welfare. When investment fails to take place, the economy enters an endogenous disaster state. We show that the possibili...