Investor Sophistication and Capital Income Inequality

Abstract

We show that capital income inequality is large and growing fast, accounting for a significant portion of total income inequality. We study its determinants in a general equilibrium portfolio choice model with endogenous information acquisition and heterogeneity across household sophistication and asset riskiness. The main mechanism works through endogenous household participation in assets with different risk. The model implies capital income inequality that increases with aggregate information technology. Quantitatively, it generates a path of capital income inequality that matches the evolution of inequality in the U.S.

Keywords: capital income inequality, investor sophistication, information frictions

JEL Classification: G12, E44, G11, G14