Inequality, stock market participation, and the equity premium

Over the last 25 years, labor income inequality has increased significantly; one may expect this would lead to significant increases in wealth and consumption inequality. However the increase in wealth inequality has been relatively moderate and consumption inequality has barely increased at all. At the same time, stock market participation has increased and the equity premium has declined. I solve a general equilibrium model to show that there is an intimate link between market participation and inequality. When wage inequality increases without a change to participation costs, the model predicts large increases in wealth and consumption inequality and a drop in market participation. However, if in addition, partici- pation costs fall to match the increase in participation observed in the data, the model predicts changes in wealth and consumption inequality quantitatively similar to those observed in the data, as well as a large decline in the equity premium.