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The Welfare Cost of Business Cycles with Heterogeneous Trading Technologies

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Abstract

The author investigates the welfare cost of business cycles in an economy where households have heterogeneous trading technologies. In an economy with aggregate risk, the different portfolio choices induced by heterogeneous trading technologies lead to a larger consumption inequality in equilibrium, while this source of inequality vanishes in an economy without business cycles. Put simply, the heterogeneity in trading technologies amplifies the effect of aggregate output fluctuation on consumption inequality. The welfare cost of business cycles is, therefore, larger in such an economy. In the benchmark economy with a reasonably low risk aversion rate, the business cycle cost is 6.49 percent per- period consumption for an average household when the model is calibrated to match the risk premium.

Suggested Citation

  • YiLi Chien, 2015. "The Welfare Cost of Business Cycles with Heterogeneous Trading Technologies," Review, Federal Reserve Bank of St. Louis, vol. 97(1), pages 67-85.
    • Handle: RePEc:fip:fedlrv:00037
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    References listed on IDEAS

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    1. YiLi Chien & Harold Cole & Hanno Lustig, 2012. "Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Rebalancing?," American Economic Review, American Economic Association, vol. 102(6), pages 2859-2896, October.
    2. Dirk Krueger & Fabrizio Perri, 2006. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory -super-1," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 73(1), pages 163-193.
    3. Jonathan A. Parker & Annette Vissing-Jorgensen, 2009. "Who Bears Aggregate Fluctuations and How?," American Economic Review, American Economic Association, vol. 99(2), pages 399-405, May.
    4. Yili Chien & Harold Cole & Hanno Lustig, 2011. "A Multiplier Approach to Understanding the Macro Implications of Household Finance," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 78(1), pages 199-234.
    5. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, August.
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    More about this item

    JEL classification:

    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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