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Pareto Extrapolation: Bridging Theoretical and Quantitative Models of Wealth Inequality

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  • Gouin-Bonenfant, Emilien
  • Toda, Alexis Akira

Abstract

We propose a new, systematic approach for analyzing and solving heterogeneous-agent models with fat-tailed wealth distributions. Our approach exploits the asymptotic linearity of policy functions and the analytical characterization of the Pareto exponent to make the solution algorithm more transparent, efficient, and accurate with zero additional computational cost. As an application, we solve a heterogeneous-agent model that features persistent earnings and investment risk, borrowing constraint, portfolio decision, and endogenous Pareto-tailed wealth distribution. We show that relaxing the borrowing limit from 25% of annual income to 250% increases inequality by reducing the bottom 50% wealth share from 11% to 6.7% and decreases welfare by 8.2% in consumption equivalent.
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  • Gouin-Bonenfant, Emilien & Toda, Alexis Akira, 2018. "Pareto Extrapolation: Bridging Theoretical and Quantitative Models of Wealth Inequality," University of California at San Diego, Economics Working Paper Series qt90n2h2bb, Department of Economics, UC San Diego.
    • Handle: RePEc:cdl:ucsdec:qt90n2h2bb
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    2. Ma, Qingyin & Stachurski, John & Toda, Alexis Akira, 2020. "The income fluctuation problem and the evolution of wealth," Journal of Economic Theory, Elsevier, vol. 187(C).
    3. Fischer, Thomas, 2019. "Determinants of Wealth Inequality and Mobility in General Equilibrium," Working Papers 2019:22, Lund University, Department of Economics.
    4. Ma, Qingyin & Toda, Alexis Akira, 2022. "Asymptotic linearity of consumption functions and computational efficiency," Journal of Mathematical Economics, Elsevier, vol. 98(C).
    5. Ma, Qingyin & Toda, Alexis Akira, 2021. "A theory of the saving rate of the rich," Journal of Economic Theory, Elsevier, vol. 192(C).

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