Wealth Inequality and Safe Asset Demand

Abstract

This paper studies how wealth inequality shapes the demand for safe assets in heterogeneous-agent economies. We show that asset bubbles arise when agents face a sufficiently high probability of falling into extreme poverty. In such cases, an asset insulated from idiosyncratic risk becomes infinitely large relative to agents' wealth ex-post, which makes it infinitely valuable ex-ante. This mechanism is fundamentally different from classic rational bubbles, and can generate bubbles even under stationary wealth distributions and in the absence of aggregate uncertainty and growth. Using this insight, we revisit the pricing of long-lived assets in standard heterogeneous-agent economies, and show that prior analyses may be incomplete due to overlooked possibility of transversality condition violation.

Keywords: Asset Bubble, Heterogeneous Agents, Wealth Inequality