Risk aversion heterogeneity and the investment-uncertainty relationship

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Abstract

We develop a dynamic macroeconomic model encompassing heterogeneity in households' attitudes towards risk, and we allow agents to share aggregate volatility by trading safe assets. In equilibrium, when volatility increases, low-risk-averse households, who hold a long position in risky assets, perceive a higher certainty-equivalent future return on capital. The perceived yield may also increase for high-risk-averse agents, who hold riskless assets. In response to a rise in certainty-equivalent expected returns, savings decrease due to a limited willingness to substitute consumption over time. This generates a negative response of aggregate investment to an increase in systematic volatility, showing that the aggregate behavior of an heterogeneous agents economy can be different from the behavior originating from an `average' representative agent. The appearance of degenerate wealth distributions is avoided by allowing the risk aversion of each household to change stochastically over time.
Original languageEnglish
Pages (from-to)223-264
Number of pages42
JournalJOURNAL OF ECONOMICS
Volume2019
DOIs
Publication statusPublished - 2019

Keywords

  • Aggregate investment
  • heterogeneity
  • risk aversion
  • volatility

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