26 Pages Posted: 18 May 2017
Date Written: March 2017
I study a production economy in which productivity critically depends on the balance between public and private sector. Two counteracting effects, namely flight-to-safety effect and rebalancing effect, drive the macroeconomic quantities and asset prices. When calibrated to the U.S. economy, the model matches a number of macro and asset pricing moments, and generates two main implications: (1) Risk aversion and precautionary saving motive could transcend asset markets and have a distributional impact on real investment. (2) “Flight to safety” could lead to capital misallocation and thus crimped economic growth, which take a long time to recover. Finally, I test the model’s implication in the cross-section of equity returns and find supportive evidence.
Keywords: Uncertainty, Misallocation, Flight to Safety
JEL Classification: E44, G00, G18
Suggested Citation: Suggested Citation