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Financial Markets Incompleteness and Inequality Over the Life-Cycle

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  • Jaime Ruiz-Tagle

Abstract

This paper addresses the relevance of contemporary uncertainty under incomplete markets in explaining wealth and consumption inequality when preferences are homogeneous. We explore the role of illiquid saving (saving that cannot be used to buffer contemporary shocks) generated by contemporary uncertainty, and a cost of liquidating saving, in generating differences in saving behaviour between initially-rich and initially-poor in a numerically solved life-cycle model. We observe that the existence of a risk premium significantly increases the ability of the households to accumulate wealth to finance their consumption, even under high risk aversion. We find that there is increasing consumption inequality across the life-cycle between groups, and that this result is boosted by access to risky assets and higher values of the coefficient of risk aversion. Critically, the possibility to borrow against saving helps to prevent increased consumption inequality paths, which is the effect of illiquid saving under contemporary uncertainty. Our findings may help us to understand why the poor save so little, and therefore support social programmes that guarantee a minimum consumption for those below a certain level of wealth to allow them to catch up with wealthier individuals.

Suggested Citation

  • Jaime Ruiz-Tagle, 2006. "Financial Markets Incompleteness and Inequality Over the Life-Cycle," Working Papers Central Bank of Chile 405, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:405
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    Cited by:

    1. Pierpaolo Benigno & Michael Woodford, 2007. "Optimal Inflation Targeting under Alternative Fiscal Regimes," Central Banking, Analysis, and Economic Policies Book Series,in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 3, pages 037-075 Central Bank of Chile.
    2. Nicoletta Batini & Douglas Laxton, 2007. "Under What Conditions Can Inflation Targeting Be Adopted? The Experience of Emerging Markets," Central Banking, Analysis, and Economic Policies Book Series,in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 12, pages 467-506 Central Bank of Chile.

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