Asset Prices and Efficiency in a Krebs Economy
32 Pages Posted: 18 Apr 2014 Last revised: 5 Dec 2015
Date Written: November 18, 2014
I study the asset pricing implications and the efficiency of a tractable dynamic stochastic general equilibrium model with heterogeneous agents and incomplete markets along the lines of Krebs (2003a). Contrary to previous applications of these types of models, I find that generically the distribution of idiosyncratic shocks affects the risk premia of aggregate shocks and that the equilibrium is constrained inefficient in the sense that a planner can Pareto improve the equilibrium outcome by assigning different portfolio choices to agents. The inefficiency is caused by a 'portfolio externality': the average portfolio of the economy affects the portfolio return of each agent. The constrained efficient outcome can be achieved through linear taxes and subsidies that I characterize in closed-form.
Keywords: AK models, constrained efficiency, externality, idiosyncratic risk, incomplete markets, optimal taxation
JEL Classification: D52, D58, E21, E22, G11, H21, H23
Suggested Citation: Suggested Citation