Heterogeneous Risk Preferences and the Welfare Cost of Business Cycles

Sam Schulhofer-Wohl

Review of Economic Dynamics, 2008, vol. 11, issue 4, 761-780

Abstract: I study the welfare cost of business cycles in a complete-markets economy where some people are more risk averse than others. Relatively more risk-averse people buy insurance against aggregate risk, and relatively less risk-averse people sell insurance. These trades reduce the welfare cost of business cycles for everyone. Indeed, the least risk-averse people benefit from business cycles. Moreover, even infinitely risk-averse people suffer only finite and, in my empirical estimates, very small welfare losses. In other words, when there are complete insurance markets, aggregate fluctuations in consumption are essentially irrelevant not just for the average person -- the surprising finding of Lucas (1987) -- but for everyone in the economy, no matter how risk averse they are. If business cycles matter, it is because they affect productivity or interact with uninsured idiosyncratic risk, not because aggregate risk per se reduces welfare. (Copyright: Elsevier)

Keywords: Business cycles; Risk aversion; Risk sharing; Heterogeneity (search for similar items in EconPapers)
JEL-codes: E21 E32 (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (20)

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DOI: 10.1016/j.red.2008.01.003

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