Working Paper: NBER ID: w31832
Authors: Marlon Azinovic; Harold L. Cole; Felix Kubler
Abstract: We examine asset prices in environments where the risk-free rate lies considerably below the growth rate. To do so, we introduce a tractable model of a production economy featuring heterogeneous trading technologies, as well as idiosyncratic and aggregate risk. We show that allowing for the possibility of firms exiting is crucial for matching key macroeconomic moments and, simultaneously, the risk-free rate, the market price of risk, and price-earnings ratios. In particular, our model allows us to consider calibrations that match the high observed market price of risk and average interest rates as low as 2-3.5 percent below the average growth rate. High values for risk aversion or non-standard preferences are not necessary for this. We use the model to examine the wealth distribution and asset prices in economies with very low real rates. We also examine under which conditions realistic calibrations allow for an infinite rollover of government debt. For our benchmark calibration, rollover is impossible even if the average risk-free rate lies 3.5 percent below the average growth rate.
Keywords: Asset Pricing; Low Interest Rates; Government Debt; Heterogeneous Households; Market Price of Risk
JEL Codes: C6; E22; E43; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| firm exit (G33) | asset pricing (G19) |
| low risk-free rate (G19) | asset prices (G19) |
| low interest rates (E43) | wealth distribution (D31) |