Working Paper: NBER ID: w17817
Authors: Florian Scheuer
Abstract: This paper studies Pareto-optimal risk-sharing arrangements in a private information economy with aggregate uncertainty and ex ante heterogeneous agents. I show how to implement Pareto-optima as equilibria when agents can trade claims to consumption contingent on aggregate shocks in financial markets. The first result is that if aggregate and idiosyncratic shocks are independent, the implementation of optimal allocations does not require any interventions in financial markets. This result can be extended to dynamic settings in the sense that, in this case, only savings need to be distorted, but not trades in financial markets. Second, I characterize optimal trading distortions in financial markets when aggregate and idiosyncratic shocks are not independent. In this case, optimal asset taxes must be higher for those securities that pay out in aggregate states in which consumption is more volatile. For instance, this can provide an efficiency justification for the frequently observed differential tax treatment of different asset classes, such as debt and equity claims.
Keywords: Pareto-optimal risk-sharing; financial markets; aggregate uncertainty; optimal taxation
JEL Codes: D8; E2; G1; H2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| independence of aggregate and idiosyncratic shocks (D89) | Pareto-optimal allocations without market distortions (D61) |
| non-independence of aggregate and idiosyncratic shocks (E19) | higher optimal asset taxes for riskier securities (G12) |
| volatility of consumption (D11) | higher asset taxes on securities that pay out in states with more volatile consumption (H73) |
| optimal asset tax schedule (H21) | justification for current differential tax treatments in financial markets (G19) |
| Pareto-optimal allocations (D61) | no required market distortions (D41) |