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Title:Heterogeneous Risk Preferences and the Welfare Cost of Business Cycles PDF Logo
Authors:Schulhofer-Wohl, Sam
Issue Date:2007
Series/Report no.:Discussion papers in economics / Princeton University, Woodrow Wilson School of Public and International Affairs 235
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 uctuations 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.
Subjects:business cycles
risk aversion
risk sharing
heterogeneity
JEL:E32
E21
Document Type:Working Paper
Appears in Collections:Discussion Papers in Economics, Woodrow Wilson School of Public and International Affairs (WWS), Princeton University

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