Macroeconomic Effects of Financial Policy

Yann Algan, Olivier Allais () and Eva Carceles-Poveda

Review of Economic Dynamics, 2009, vol. 12, issue 4, 678-696

Abstract: This paper studies the effects of financial policy in a model with heterogeneous agents, incomplete markets and portfolio restrictions. For an economy calibrated to replicate key aspects of the US wealth distribution, we find that the quantitative effects of financial policy are relatively small. The reason is that the households determining aggregate behavior are relatively well insured and can therefore offset the actions of the firm by modifying their portfolio allocations. However, financial policy has important effects on asset prices. Whereas a higher level of debt in the capital structure of the firm introduces more risk into the economy by increasing the volatility of the equity return, it enhances the liquidity of households by increasing the supply of bonds. In an economy with a substantial amount of heterogeneity, this last effect dominates and leverage leads to a decrease in the equity premium. This is in contrast to the findings in representative agent models, in which leverage unambiguously increases the premium through a higher equity return volatility. (Copyright: Elsevier)

Keywords: Incomplete markets; Heterogeneous agents; Financial policy (search for similar items in EconPapers)
JEL-codes: E44 G10 G32 (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (2)

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DOI: 10.1016/j.red.2009.02.001

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