Working Paper: CEPR ID: DP18617
Authors: Yoshiki Ando; Dirk Krueger; Harald Uhlig
Abstract: In this paper we study the neoclassical growth model with idiosyncratic income risk and aggregate risk in which risk sharing is endogenously constrained by one-sided limited commitment. Households can trade a full set of contingent claims that pay off depending on both idiosyncratic and aggregate risk, but limited commitment rules out that households sell these assets short. The model results, under suitable restrictions of the parameters of the model, in partial consumption insurance in equilibrium. With log-utility and idiosyncratic income shocks taking two values one of which is zero (e.g., employment and unemployment) we show that the equilibrium can be characterized in closed form, despite the fact that it features a non-degenerate consumption- and wealth distribution. We use the tractability of the model to study, analytically, inequality over the business cycle and asset pricing, and derive conditions under which our model has identical, as well as conditions under which it has lower/higher risk premia than the corresponding representative agent version of the model.
Keywords: Limited Commitment; Idiosyncratic Income Risk; Neoclassical Growth Model; Transitional Dynamics; Aggregate Risk
JEL Codes: E21; E23; D15; D31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| one-sided limited commitment (D86) | partial consumption insurance (G52) |
| idiosyncratic income shocks (D89) | consumption and wealth distribution (E21) |
| low interest rates or high future wage growth (E43) | not purchase contingent claims (G13) |
| not purchase contingent claims (G13) | consumption inequality (D31) |
| positive productivity shocks (O49) | consumption inequality (D31) |
| idiosyncratic risk (D81) | risk premium (G19) |