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Aging, Health Risk, and Interest Rates

Reona Hagiwara ()
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Reona Hagiwara: Faculty of Political Science and Economics, Waseda University

No 2303, Working Papers from Waseda University, Faculty of Political Science and Economics

Abstract: Over the past few decades, the Japanese economy has experienced a secular decline in the real interest rate, which is the return on safe and liquid assets. At the same time, the gap between the returns on liquid bond and illiquid capital (i.e., the risk premium) has increased because of the steady return on risky assets. This paper explores the role of the health risk in the increase in the premium, using a general equilibrium overlapping generations model. In the model, individuals are heterogeneous in health status and they incur medical costs. The model also features the presence of additional medical transaction frictions, which increase with medical expenditure but can be reduced by holding liquid assets. I find that both demographic aging and the increase in the individual out-of-pocket medical costs could push down the return on bond and lead to the widening premium. However, the latter effect is dominant because higher medical burdens encourage individuals to save more liquid bond rather than illiquid capital in order to mitigate the medical transaction frictions. According to these findings, the changes in the medical systems will continue to contribute to the further widening risk premium, although the future trend will be affected by several factors, not only medical systems but also demographics and government bond supply.

Keywords: Health Risk; Demographic Aging; Risk Premium; Overlapping Generations (search for similar items in EconPapers)
JEL-codes: E21 G51 I10 J11 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2023-07
New Economics Papers: this item is included in nep-age and nep-dge
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