Uninsured Idiosyncratic Investment Risk and Aggregate Saving
34 Pages Posted: 28 Feb 2005
Date Written: August 15, 2005
This paper augments the neoclassical growth model to study the macroeconomic effects of idiosyncratic investment risk. The general equilibrium is solved in closed form under standard assumptions for preferences and technologies. Relative to complete markets, the steady state is characterized by both a lower interest rate and a lower capital stock when the elasticity of intertemporal substitution is sufficiently high. For plausible calibrations of the model, the reduction in aggregate savings and income is quantitatively significant. Finally, cyclical variation in private investment risks is shown to amplify the transitional dynamics.
Keywords: incomplete markets, heterogeneity, private equity, entrepreneurial risk, precautionary savings, amplification
JEL Classification: D52, E13, E32, G11, O16, O41
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