Working Paper: CEPR ID: DP9636
Authors: Kenza Benhima; Baptiste Massenot
Abstract: Fear of risk provides a rationale for protracted economic downturns. We develop a real business cycle model where investors with decreasing relative risk aversion choose between a risky and a safe technology that exhibit decreasing returns. Because of a feedback effect from the interest rate to risk aversion, two equilibria can emerge: a standard equilibrium and a ``safe'' one in which investors invest in safer assets. We refer to the dynamics of this second equilibrium as a safety trap because it is self-reinforcing as investors accumulate more wealth and show it to be consistent with Japan's lost decade.
Keywords: Business Cycles; Japan's Lost Decade; Risk Aversion
JEL Codes: E22; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk aversion (D81) | investment decisions (G11) |
| investment decisions (G11) | economic outcomes (F61) |
| risk aversion (D81) | safety trap (J28) |
| safety trap (J28) | economic stagnation (P27) |
| interest rates (E43) | risk aversion (D81) |
| risk aversion (D81) | investment in risky assets (G11) |
| wealth accumulation (E21) | risk aversion (D81) |
| risk aversion (D81) | negative correlation with risky asset investment (G11) |