The Role of the Growth of Risk-Averse Wealth in the Decline of the Safe Real Interest Rate

Robert Hall ()

No 22196, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Over the past few decades, worldwide real interest rates have trended downward. The real interest rate describes the terms of trade between risk-tolerant and risk-averse investors. Debt pays off equally across contingencies at a given future date, so debt is valuable to risk-averse investors to smooth consumption across those contingencies. In an equilibrium with trade between investors who differ in attitudes toward risk, the risk-tolerant investors borrow from the risk-averse ones, shifting the risk to those whose preferences favor taking on risk. Heterogeneity in risk aversion takes two forms in the model of the paper: variation in coefficients of relative risk aversion and variation in beliefs about the probabilities of seriously adverse outcomes. If the composition of wealth shifts into the hands of investors with higher coefficients of relative risk aversion and investors who believe in higher probabilities of bad events, the real interest rate falls. The paper calculates likely magnitudes of the decline and presents evidence in favor of a shift in the composition of wealth toward the holdings of the more risk-averse. In particular, the United States absorbs large amounts of risk by borrowing from more risk-averse countries, notably China, which thereby shed corresponding amounts of risk.

JEL-codes: E43 G12 (search for similar items in EconPapers)
Date: 2016-04
New Economics Papers: this item is included in nep-pr~, nep-mac and nep-upt
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Citations: View citations in EconPapers (18)

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