Private Risk Premium and Aggregate Uncertainty in the Model of Uninsurable Investment Risk

38 Pages Posted: 16 Jan 2008

See all articles by Shigeru Fujita

Shigeru Fujita

Federal Reserve Bank of Philadelphia

Francisco Covas

Board of Governors of the Federal Reserve System

Date Written: November 15, 2007

Abstract

This paper studies cyclical properties of the private risk premium in a model where a continuum of heterogeneous entrepreneurs are subject to aggregate as well as idiosyncratic risks, both of which are assumed to be highly persistent. The calibrated model matches highly skewed wealth and income distributions of entrepreneurs found in the Survey of Consumer Finances. The authors provide an accurate numerical solution to the model even though the model is shown to exhibit serious nonlinearities that are absent in incomplete market models with idiosyncratic labor income risk. The model is able to generate the aggregate private risk premium of 2-3 percent and the low risk-free rate. However, it generates very little variation in these variables over the business cycle, suggesting that the model lacks the ability to amplify aggregate shocks.

Keywords: Uninsurable investment risk, aggregate uncertainty, private risk premium

JEL Classification: E22, G11, M13

Suggested Citation

Fujita, Shigeru and Covas, Francisco, Private Risk Premium and Aggregate Uncertainty in the Model of Uninsurable Investment Risk (November 15, 2007). FRB of Philadelphia Working Paper No. 07-30. Available at SSRN: https://ssrn.com/abstract=1077212 or http://dx.doi.org/10.2139/ssrn.1077212

Shigeru Fujita

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Francisco Covas (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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