Risk, Uncertainty, and the Dynamics of Inequality

Kenneth Kasa and Xiaowen Lei

Discussion Papers from Department of Economics, Simon Fraser University

Abstract: This paper studies the dynamics of wealth inequality in a continuous-time Blanchard/Yaari model. Its key innovation is to assume that idiosyncratic investment returns are subject to (Knightian) uncertainty. In response, agents formulate robust portfolio policies (Hansen and Sargent (2008)). These policies are nonhomothetic; wealthy agents invest a higher fraction of their wealth in uncertain assets yielding higher mean returns. This produces an endogenous feedback mechanism that amplifies inequality. It also produces an accelerated rate of convergence, which resolves a puzzle recently identified by Gabaix, Lasry, Lions, and Moll (2016). We ask the following question -Suppose the US was in a stationary distribution in 1980, and the world suddenly became more ‘uncertain’. Could this uncertainty explain both the magnitude and pace of recent US wealth inequality? Using detection error probabilities to discipline the degree of uncertainty, we conclude the answer is ‘Yes’.

Keywords: inequality; robustness (search for similar items in EconPapers)
JEL-codes: D31 D81 (search for similar items in EconPapers)
Pages: 30
Date: 2017-01
New Economics Papers: this item is included in nep-dem
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Citations: View citations in EconPapers (6)

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Journal Article: Risk, uncertainty, and the dynamics of inequality (2018)
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