Uninsured Idiosyncratic Investment Risk: Positive and Normative Implications
The neoclassical growth model is augmented to study the macroeconomic effects of uninsured idiosyncratic investment risk. As compared to complete markets, the steady state is characterized by both a lower interest rate and a lower capital stock when the elasticity of intertemporal substitution is sufficiently high relative to the contribution of private equity in total wealth. Turning to normative implications, the constrained efficient level of investment in a two-period version of the model is higher than the equilibrium one---and hence a subsidy on investment is optimal---even in situations where the equilibrium features higher capital that the first best. While the positive results contrast with Bewley-type models, where labor-income risk necessarily leads to higher aggregate saving, the normative results highlight how idiosyncratic investment (or entrepreneurial) risk can have novel implications also for optimal taxation
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|Date of creation:||03 Dec 2006|
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