Idiosyncratic Risk, Aggregate Risk, and the Welfare Effects of Social Security

Harenberg, Daniel; Ludwig, Alexander

doi:10.1111/iere.12365

Cited by 24 publications

(23 citation statements)

References 85 publications

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“…For example,Storesletten et al (2001) find the direct effect to be an order of magnitude smaller than the role of cyclical variation in idiosyncratic risk. However, there can be indirect utility "interactions" between aggregate and idiosyncratic risk, which may be large(Harenberg and Ludwig 2019), and which we abstract from here to focus on the role of the idiosyncratic shock distribution.32 When using log-Normal distributions of shocks, a typical approach in the literature is to consider an average distribution, which features the average of expansion and contraction variances, see for exampleStoresletten et al (2001).…”

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confidence: 99%

Higher-Order Income Risk over the Business Cycle

Busch

Ludwig

2020

SSRN Journal

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We extend the canonical income process with persistent and transitory risk to shock distributions with left-skewness and excess kurtosis, to which we refer as higherorder risk. We estimate our extended income process by GMM for household data from the United States. We find countercyclical variance and procyclical skewness of persistent shocks. All shock distributions are highly leptokurtic. The existing tax and transfer system reduces dispersion and left-skewness of shocks. We then show that in a standard incomplete-markets life-cycle model, first, higher-order risk has sizable welfare implications, which depend crucially on risk attitudes of households; second, higher-order risk matters quantitatively for the welfare costs of cyclical idiosyncratic risk; third, higher-order risk has non-trivial implications for the degree of self-insurance against both transitory and persistent shocks.

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confidence: 99%

Higher-Order Income Risk over the Business Cycle

Busch

Ludwig

2020

SSRN Journal

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“…Instead of using a perceived laws of motion for the bond interest rate, like Krusell and Smith (1997) and Algan et al (2009), I use the perceived law of motion for the equity premium. This method facilitates computation, because during the course of solving the model, predicting negative equity premium is eliminated if logarithmic rules are used (see Harenberg and Ludwig (2018)). For details about the solution algorithm, see the Appendix.…”

Section: Solution Methodsmentioning

confidence: 99%

“…Furthermore, Krusell and Smith (1997) add portfolio choice to the model with both idiosyncratic and aggregate risk and allow the households to save in both capital and zero supply bonds. Papers such as Harenberg and Ludwig (2018), Krueger and Kubler (2006) and Gomes et al (2013) add an overlapping-generations (OLG) structure on top of the complexity of Krusell and Smith (1997). One of the more similar models is in Algan et al (2009), which does not have OLG structure, but adds a positive supply of both bonds and capital, which are issued by a leveraged firm.…”

Section: Introductionmentioning

confidence: 99%

“…Therefore, my model differentiates from Algan et al (2009) in that it contains OLG structure and an additional discrete decision. Furthermore, it is different from Harenberg and Ludwig (2018), Gomes et al (2013), and Krueger and Kubler (2006), because it has a more parsimonious OLG structure, and at the same time it has additional discrete decision and positive supply of bonds from a leveraged firm.…”

Section: Introductionmentioning

confidence: 99%

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Firm Leverage and Wealth Inequality

Bakota

2020

SSRN Journal

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This paper studies the effects of a change in firm leverage on wealth inequality and macroeconomic aggregates. The question is studied in a general equilibrium model with a continuum of heterogeneous agents, life-cycle, incomplete markets, and idiosyncratic and aggregate risk. The analysis focuses on the particular change in firm leverage that occurred in the U.S. during the 1980s, when firm leverage increased significantly, and subsequently has been dropping since the early 1990s. In the benchmark model, an increase in firm leverage of the size that occurred during the 1980s increases capital accumulation by 5.38%, decreases wealth inequality by 1.07 Gini points and decreases government revenues by 0.11% of output. An increase in firm leverage increases average after-tax returns on savings, as firm debt has beneficial tax treatment. This increases the saving rates of all households, and disproportionately increases the saving rates of relatively poorer households. Consequently, the model implies that the increase in firm leverage did not contribute to rising inequality in the U.S. in the 1980s, but rather the opposite; that the reduction in leverage from the early 1990s to 2008 has contributed to rising wealth inequality. Furthermore, I show that if the model abstracts from beneficial tax treatment of corporate debt, the change in leverage has only minor effects on macro aggregates and inequality, despite having significant implications for asset prices. This is consistent with the previous result in the literature showing that the Modigliani-Miller theorem approximately holds in the heterogeneous agents model with imperfect markets.

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Section: Welfare Costs Of Cyclical Idiosyncratic Riskmentioning

confidence: 99%