Working Paper: NBER ID: w25448
Authors: Pietro Veronesi
Abstract: I characterize a dynamic economy under general distributions of households’ risk tolerance, endowments, and beliefs about long-term growth. As the economy expands and the stock market rises (a) the fraction of households with declining consumption-share increases; (b) the wealth-share of high risk-tolerant households increases; (c) richer households’ wealth display a higher CAPM beta; and (d) households’ portfolios change qualitatively. A log-utility investor for instance borrows in contractions but lends in expansions. Variations in uncertainty and expected growth generate trading volume due to risk sharing. Higher uncertainty increases stock prices, risk premiums, volatility, wealth inequality and the dispersion of portfolio holdings, consistently with the events in the late 1990s.
Keywords: Risk Tolerance; Wealth Inequality; Asset Pricing; Macroeconomic Uncertainty
JEL Codes: E21; G1; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher dispersion of risk preferences (D81) | higher Sharpe ratios (G40) |
| higher dispersion of risk preferences (D81) | higher risk-free rates during adverse economic conditions (E44) |
| higher dispersion of risk preferences (D81) | lower risk-free rates in favorable times (G19) |
| risk sharing occurs as households with higher risk tolerance insure those with lower risk tolerance (G52) | dynamics of risk sharing and wealth distribution (D39) |
| variations in uncertainty and expected growth (D89) | trading volume driven by risk sharing (G15) |
| variations in uncertainty and expected growth (D89) | increased stock prices (G10) |
| variations in uncertainty and expected growth (D89) | increased risk premiums (G19) |
| variations in uncertainty and expected growth (D89) | increased volatility (E32) |
| variations in uncertainty and expected growth (D89) | increased wealth inequality (D31) |
| economic expansion and rising stock market (P17) | increasing fraction of households with declining consumption share (D12) |
| economic expansions (E32) | wealth share of high-risk tolerant households increases (G59) |
| wealth dynamics of richer households (D14) | higher CAPM beta (C46) |
| portfolio allocations undergo qualitative changes (G11) | log-utility investors engage in borrowing during economic contractions and lending during expansions (G19) |