Stationary equilibrium distributions in economies with limited commitment

Tobias Broer

No ECO2009/39, Economics Working Papers from European University Institute

Abstract: Limited commitment to contracts can explain imperfect risk sharing even when individuals have access to complete insurance markets. Past contributions have focused on the resulting cross-sectional distribution of consumption (Cordoba 2008, Krueger and Perri 2006). In contrast, this paper looks at the joint dynamics of income, consumption and wealth implied by the asymmetric nature of partial insurance under limited commitment, where negative income shocks are largely insured but positive shocks can lead to large rises in consumption. A theoretical section proves the existence and uniqueness of equilibrium in a limited commitment continuum economy where incomes follow a standard markov process, and solves analytically for the joint equilibrium distribution of consumption, income and wealth. I show that individual consumption follows, at least locally, a left-skewed geometric distribution. Also, the conditional distributions of consumption and wealth are highly non-linear and have a characteristic form of heteroscedasticity, with declining conditional variances as income increases. In a quantitative part, the paper compares the exact distributions in the Krueger and Perri (2006) model to non-parametric estimates of their counterparts in US micro-data, and in a simple Ayagari economy.

Keywords: Risk Sharing; Limited Commitment; Inequality; Wealth and Consumption Distribution; Participation Constraints; Default (search for similar items in EconPapers)
JEL-codes: D31 D52 E21 E44 (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-bec and nep-dge
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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