Who Hedges Interest-rate Risk? Implications for Wealth Inequality

Abstract

We present a life-cycle model in which households can invest in short- or long-term assets to hedge against interest-rate risk. Our model matches important stylized facts. First, the share of long-term assets in households' wealth is hump-shaped over the life-cycle. Within cohorts, it increases with wealth and earnings. Second, wealth inequality grows when interest rates fall, but only when wealth does not include the value of Social Security. Hedging demand against interest-rate risk can explain 40% of long-run changes in wealth inequality since 1960.

Keywords: Interest rates, Portfolio choices, Inequality, Social Security

JEL Classification: D31, E21, G51, H55