Shaofeng Xu (Bank of Canada): Robustness, Wealth Distribution, and Asset Prices
Co-authors: Edouard Djeutem (Bank of Canada) and Kenneth Kasa (Simon Fraser University)
This paper studies the implications of wealth distribution for asset prices. We document from historical data that wealth inequality is an important driver of asset prices. To explain this observation, we develop an analytically tractable OLG general equilibrium model with aggregate shocks and robustness a la Hansen and Sargent (2008). In the economy, households are heterogenous in their wealth and they confront Knightian uncertainty about the model governing stock market returns. It is shown that response to model uncertainty depends negatively on the wealth level, and this gives rise to nonhomothetic consumption-portfolio policies. We find that robustness has an important impact on the model's qualitative and quantitative ability to explain some key asset pricing observations, in particular the interactions between wealth inequality and asset prices. Our study contributes to the literature by proposing a new channel (robustness) through which household heterogeneity matters for the macroeconomy.
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