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Title: Inequality, Portfolio Choice and the Business Cycle
Citation Type: Miscellaneous
Publication Year: 2017
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Abstract: I study the effect of heterogeneity, in both the level and composition of wealth, in a dynamic stochastic overlapping-generations economy where households face uninsurable unemployment, earnings, and liquidity risk. Households pay transactions costs when they adjust savings held in high expected return assets, which make such savings illiquid. They also hold liquid, lower return assets. I show that household-level disparities in liquidity are important for understanding differences in their behavior, as well as aggregate changes in consumption and investment, over the Great Recession. When I allow for a rise in both unemployment and disaster risk, reducing households’ expected income and the expected return on their illiquid savings, aggregate consumption and investment fall to levels seen in the recession. The response of aggregate consumption is sensitive to the behavior of wealth poor households with a high marginal utility of consumption. Facing a large possible fall in earnings, they build precautionary savings in liquid assets. However, in a typical incomplete markets model with a single asset, all households would respond to the fall in the expected return on savings following a rise in disaster risk. The resulting substitution effect would offset much of the negative wealth effect on aggregate consumption. In contrast, when much of wealth is illiquid, many households do not respond to a fall in its expected return, substantially dampening the substitution effect. Moreover, wealthier households, more likely to adjust their portfolios, increase their shares of liquid assets. This results in a large fall in aggregate investment.
Url: http://www.econweb.umd.edu/~davis/eventpapers/KimInequality.pdf
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Authors: Kim, Heejeong
Publisher: Concordia University
Data Collections: IPUMS USA
Topics: Other, Poverty and Welfare
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