THE RISK-FREE RATE IN A FINITE HORIZON MODEL WITH BEQUESTS

Xiaoyong Cui and Liutang Gong

Bulletin of Economic Research, 2015, vol. 67, issue 2, 105-114

Abstract: type="main">

This paper studies the risk-free rate in an overlapping generations economy with bequests. It is shown that the risk-free rate depends on risk aversion, the elasticity of intertemporal substitution, the share of wealth invested in human wealth, life expectancy, and the preference for bequests. In a standard life-cycle context, mortality increases the subjective time rate of discount, and thus increases the compensation required to postpone consumption. This latter effect is offset in a bequest-driven model of the type considered here, leading to much more powerful income effects. In this sense, the model provides a bequest-motive explanation for the risk-free rate puzzle put forward by Weil in 1989.

Date: 2015
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