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Debt-Constraints or Incomplete Markets? A Decomposition of the Wealth and Consumption Inequality in the U.S

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Author Info
Juan-Carlos Cordoba (Rice University)

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Abstract

The large wealth and consumption inequality in the U.S. is usually attributed to two market frictions: debt constraints and incomplete markets. Recent literature has argued that debt constraints are the critical friction while market incompleteness plays only a secondary role. We evaluate the independent role of debt constraints versus market incompleteness to explain U.S. inequality. We introduce full insurance opportunities in a standard model of inequality along the lines of Aiyagari (1994). Debt constraints are the only friction in such model. We find that for a quite standard calibration of the income process, that of Heaton and Lucas (1996), debt constraints alone can explain none of the observed inequality. The reason is that the U.S. capital stock would be enough to secure all required contingent debts if markets were completed. Using various non-standard calibrations, we find that debt constraints can play an important role to explain inequality but still market incompleteness remains as the main friction. In particular, debt- constrained models cannot account for the large wealth dispersion and wealth concentration in the top tail of the distribution in the U.S.

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Paper provided by EconWPA in its series Macroeconomics with number 0404004.

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Length: 37 pages
Date of creation: 05 Apr 2004
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Handle: RePEc:wpa:wuwpma:0404004

Note: Type of Document - pdf; pages: 37
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Related research
Keywords: Idiosyncratic Risk; Incomplete Markets; Borrowing Constraints; Wealth Distribution;

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Find related papers by JEL classification:
E2 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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  3. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June. [Downloadable!] (restricted)
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    Other versions:
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