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Safety Traps

  • Kenza Benhima
  • Baptiste Massenot

Fear of risk provides a rationale for protracted economic downturns. We develop a real business cycle model where investors with decreasing relative risk aversion choose between a risky and a safe technology that exhibit decreasing returns. Because of a feedback effect from the interest rate to risk aversion, two equilibria can emerge: a standard equilibrium and a "safe" one in which investors invest in safer assets. We refer to the dynamics of this second equilibrium as a safety trap because it is self-reinforcing as investors accumulate more wealth and show it to be consistent with Japan's lost decade.

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File URL: http://www.hec.unil.ch/deep/textes/12.04.pdf
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Paper provided by Université de Lausanne, Faculté des HEC, DEEP in its series Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) with number 12.04.

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Length: 41 pp. + figures and table
Date of creation: May 2012
Date of revision:
Handle: RePEc:lau:crdeep:12.04
Contact details of provider: Postal: Université de Lausanne, Faculté des HEC, DEEP, Internef, CH-1015 Lausanne
Phone: ++41 21 692.33.20
Web page: http://www.hec.unil.ch/deep/publications/cahiers/series
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  1. Andrew B. Abel, 1990. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
  2. Laurent-Emmanuel Calvet & Paolo Sodini & John Y. Campbell, 2009. "Fight Or Flight? Portfolio Rebalancing by Individual Investors," Post-Print hal-00459683, HAL.
  3. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Fumio Hayashi & Edward C. Prescott, 2002. "The 1990s in Japan: A Lost Decade," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(1), pages 206-235, January.
  5. Graham, Bryan S. & Jonathan Temple, 2002. "Rich Nations, Poor Nations: How much can multiple equilibria explain?," Royal Economic Society Annual Conference 2002 91, Royal Economic Society.
  6. Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, 2000. "Habit persistence, asset returns and the business cycle," Staff Report 280, Federal Reserve Bank of Minneapolis.
  7. Kraay, Aart & Loayza, Norman & Servén, Luis & Ventura, Jaume, 2001. "Country Portfolios," CEPR Discussion Papers 2974, C.E.P.R. Discussion Papers.
  8. G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
  9. Ricardo J. Caballero & Takeo Hoshi & Anil K. Kashyap, 2006. "Zombie Lending and Depressed Restructuring in Japan," NBER Working Papers 12129, National Bureau of Economic Research, Inc.
  10. Bengt Holmstrom & Jean Tirole, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," Working papers 95-1, Massachusetts Institute of Technology (MIT), Department of Economics.
  11. Benhima, Kenza & Massenot, Baptiste, 2013. "Safety Traps," CEPR Discussion Papers 9636, C.E.P.R. Discussion Papers.
  12. Laurent E. Calvet & John Y. Campbell & Paolo Sodini, 2009. "Fight Or Flight? Portfolio Rebalancing by Individual Investors-super-," The Quarterly Journal of Economics, MIT Press, vol. 124(1), pages 301-348, February.
  13. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  14. Howitt, Peter & McAfee, R Preston, 1988. "Stability of Equilibria with Externalities," The Quarterly Journal of Economics, MIT Press, vol. 103(2), pages 261-77, May.
  15. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
  16. Kenza Benhima, 2008. "A Reappraisal of the Allocation Puzzle through the Portfolio Approach," EconomiX Working Papers 2008-27, University of Paris West - Nanterre la Défense, EconomiX.
  17. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  18. Angeletos, George-Marios & Panousi, Vasia, 2009. "Revisiting the supply side effects of government spending," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 137-153, March.
  19. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May.
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