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Model Uncertainty and Wealth Distribution

Edouard Djeutem and Shaofeng Xu

Staff Working Papers from Bank of Canada

Abstract: This paper studies the implications of model uncertainty for wealth distribution in a tractable general equilibrium model with a borrowing constraint and robustness à la Hansen and Sargent (2008). Households confront model uncertainty about the process driving the return of the risky asset, and they choose robust policies. We find that in the presence of a borrowing constraint, model distortion varies non-monotonically with wealth. Robustness generates two forces that amplify wealth inequality. On the one hand, it increases the speed at which the wealth of unlucky households hits the borrowing constraint. On the other hand, it leads richer households to invest a disproportionately larger share of wealth in the higher yielding asset. Our study also shows that model uncertainty results in an aggregate welfare loss unevenly distributed across households.

Keywords: Asset Pricing; Business fluctuations and cycles; Economic models (search for similar items in EconPapers)
JEL-codes: D3 D8 E2 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2019-12
New Economics Papers: this item is included in nep-dge, nep-mac and nep-ore
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Handle: RePEc:bca:bocawp:19-48