IDEAS home Printed from https://ideas.repec.org/p/fip/fedlwp/2014-015.html
   My bibliography  Save this paper

The cost of business cycles with heterogeneous trading technologies

Author

Abstract

This paper 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 reasonable low risk aversion rate, the business cycle costs 6.49% per period consumption for an average household when I calibrate this model to match the risk premium.

Suggested Citation

  • YiLi Chien, 2014. "The cost of business cycles with heterogeneous trading technologies," Working Papers 2014-15, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:2014-015
    as

    Download full text from publisher

    File URL: http://research.stlouisfed.org/wp/2014/2014-015.pdf
    File Function: Full text
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    2. tom krebs, 2004. "welfare cost of business cycles when markets are incomplete," Econometric Society 2004 North American Summer Meetings 283, Econometric Society.
    3. Tom Krebs, 2007. "Job Displacement Risk and the Cost of Business Cycles," American Economic Review, American Economic Association, vol. 97(3), pages 664-686, June.
    4. Alvarez, Fernando & Jermann, Urban J, 2001. "Quantitative Asset Pricing Implications of Endogenous Solvency Constraints," The Review of Financial Studies, Society for Financial Studies, vol. 14(4), pages 1117-1151.
    5. 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.
    6. Per Krusell & Toshihiko Mukoyama & Aysegul Sahin & Anthony A. Smith, Jr., 2009. "Revisiting the Welfare Effects of Eliminating Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 393-402, July.
    7. 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.
    8. Abel, Andrew B., 1999. "Risk premia and term premia in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 3-33, February.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Rudebusch, Glenn D. & Swanson, Eric T., 2008. "Examining the bond premium puzzle with a DSGE model," Journal of Monetary Economics, Elsevier, vol. 55(Supplemen), pages 111-126, October.
    2. Chien, YiLi & Naknoi, Kanda, 2015. "The risk premium and long-run global imbalances," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 299-315.
    3. Rhys Bidder & Ian Dew-Becker, 2016. "Long-Run Risk Is the Worst-Case Scenario," American Economic Review, American Economic Association, vol. 106(9), pages 2494-2527, September.
    4. Sang Byung Seo & Jessica A. Wachter, 2019. "Option Prices in a Model with Stochastic Disaster Risk," Management Science, INFORMS, vol. 65(8), pages 3449-3469, August.
    5. Bekaert, Geert & Engstrom, Eric & Grenadier, Steven R., 2010. "Stock and bond returns with Moody Investors," Journal of Empirical Finance, Elsevier, vol. 17(5), pages 867-894, December.
    6. Ravi Bansal, 2007. "Long-run risks and financial markets," Review, Federal Reserve Bank of St. Louis, vol. 89(Jul), pages 283-300.
    7. Yu Chen & Thomas Cosimano & Alex Himonas, 2008. "Solving an asset pricing model with hybrid internal and external habits, and autocorrelated Gaussian shocks," Annals of Finance, Springer, vol. 4(3), pages 305-344, July.
    8. Martin Lettau & Sydney C. Ludvigson & Jessica A. Wachter, 2008. "The Declining Equity Premium: What Role Does Macroeconomic Risk Play?," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1653-1687, July.
    9. Seppala, Juha, 2004. "The term structure of real interest rates: theory and evidence from UK index-linked bonds," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1509-1549, October.
    10. Fabrice Collard & Sujoy Mukerji & Kevin Sheppard & Jean‐Marc Tallon, 2018. "Ambiguity and the historical equity premium," Quantitative Economics, Econometric Society, vol. 9(2), pages 945-993, July.
    11. Emi Nakamura & Jón Steinsson & Robert Barro & José Ursúa, 2013. "Crises and Recoveries in an Empirical Model of Consumption Disasters," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 35-74, July.
    12. Kihlstrom, Richard, 2009. "Risk aversion and the elasticity of substitution in general dynamic portfolio theory: Consistent planning by forward looking, expected utility maximizing investors," Journal of Mathematical Economics, Elsevier, vol. 45(9-10), pages 634-663, September.
    13. Daniel Harenberg & Alexander Ludwig, "undated". "Social Security and the Interactions Between Aggregate and Idiosyncratic Risk," Working Papers ETH-RC-14-002, ETH Zurich, Chair of Systems Design.
    14. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2009. "Quantitative Macroeconomics with Heterogeneous Households," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 319-354, May.
    15. YiLi Chien & Hanno Lustig, 2010. "The Market Price of Aggregate Risk and the Wealth Distribution," The Review of Financial Studies, Society for Financial Studies, vol. 23(4), pages 1596-1650, April.
    16. Wonnho Choi, 2014. "Habit Formation and Risk-free Rate Puzzle," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 5(4), pages 155-170, October.
    17. YiLi Chien & Harold L. Cole & Hanno Lustig, 2014. "Implications of heterogeneity in preferences, beliefs and asset trading technologies for the macroeconomy," Working Papers 2014-14, Federal Reserve Bank of St. Louis.
    18. Kyle Chauvin & David Laibson & Johanna Mollerstrom, 2011. "Asset Bubbles and the Cost of Economic Fluctuations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 233-260, August.
    19. Karen K. Lewis & Edith X. Liu, 2022. "How Can Asset Prices Value Exchange Rate Wedges?," Finance and Economics Discussion Series 2022-075, Board of Governors of the Federal Reserve System (U.S.).
    20. Dionne, Georges & Li, Jingyuan, 2014. "When can expected utility handle first-order risk aversion?," Journal of Economic Theory, Elsevier, vol. 154(C), pages 403-422.

    More about this item

    Keywords

    Asset Pricing; Cost of Business Cycles; Heterogeneous Agents;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedlwp:2014-015. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Anna Oates (email available below). General contact details of provider: https://edirc.repec.org/data/frbslus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.