Meritocracy and Asset Prices

Meritocracy characterizes a political system wherein economic goods are allocated based on an individual’s ability and effort, rather than social class. This paper constructs a measure of meritocracy, uncovers meritocracy’s impact on asset prices, income inequality, and effort empirically, and proposes a theoretical model that is consistent with empirical findings. Our empirical analysis demonstrates that higher levels of meritocracy are associated with a higher interest rate, lower stock price-dividend ratio, and lower stock risk premium and volatility. We also find that meritocracy plays a significant role in the real economy, with higher meritocracy related to higher levels of individual and aggregate effort and greater income inequality over the past 50 years. To shed light on these findings, we develop a dynamic model of financial markets that incorporates meritocracy in the economy. Our model provides insights that support our empirical results, uncovers the underlying mechanisms at play, and makes novel predictions regarding how heterogeneity in individual ability and social class modulates the relationship between meritocracy and inequality.