We develop a production based asset pricing model with financially constrained firms to explain the observed high equity premium and low risk-free rate volatility. Investment opportunities are scarce and firms face productivity and liquidity shocks. A negative liquidity shock forces firms to...

We develop a production based asset pricing model with financially constrained firms to explain the observed high equity premium and low risk-free rate volatility. Investment opportunities are scarce and firms face productivity and liquidity shocks. A negative liquidity shock forces firms to...