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We provide a theory of truncation for incomplete insurance-market economies with aggregate shocks, which is shown to be a consistent representation of standard incomplete-market economies. This representation allows deriving optimal policies with capital and aggregate shock. We apply this framework to an economy where the government can use capital and labor taxes, positive transfers and public debt to smooth aggregate shocks. The average capital tax is shown to be positive if and only if credit constraints are binding for some households. In a quantitative exercise, the capital tax appears to be more volatile than the labor tax and public debt is countercyclical and mean-reverting.

We provide a theory of truncation for incomplete insurance-market economies with aggregate shocks, which is shown to be a consistent representation of standard incomplete-market economies. This representation allows deriving optimal policies with capital and aggregate shock. We apply this framework to an economy where the government can use capital and labor taxes, positive transfers and public debt to smooth aggregate shocks. The average capital tax is shown to be positive if and only if credit constraints are binding for some households. In a quantitative exercise, the capital tax appears to be more volatile than the labor tax and public debt is countercyclical and mean-reverting.

We provide a theory of truncation for incomplete insurance-market economies with aggregate shocks, which is shown to be a consistent representation of standard incomplete-market economies. This representation allows deriving optimal policies with capital and aggregate shock. We apply this framework to an economy where the government can use capital and labor taxes, positive transfers and public debt to smooth aggregate shocks. The average capital tax is shown to be positive if and only if credit constraints are binding for some households. In a quantitative exercise, the capital tax appears to be more volatile than the labor tax and public debt is countercyclical and mean-reverting.

AbstractWe analyze the impact of risk aversion and ambiguity aversion on the competing demands for annuities and bequeathable savings using a lifecycle recursive utility model. Our main finding is that risk aversion and ambiguity aversion have similar effects: an increase in either of the two reduces annuity demand and enhances bond holdings. We obtain this unequivocal result in the flexible intertemporal framework of Hayashi and Miao (2011) by assuming that the agent's preferences are monotone with respect to first-order stochastic dominance. Our contribution is then twofold. First, from a decision-theoretic point of view, we show that monotonicity allows one to obtain clear-cut results about the respective roles of risk and ambiguity aversion. Second, from the insurance point of view, our result that the demand for annuities decreases with risk and ambiguity aversion stands in contrast with what is usually found with other insurance products. As such, it may help explain the low annuitization level observed in the data.

We analyse the term structure of interest rates in a general equilibrium model with incomplete markets, borrowing constraint, and positive net supply of government bonds. Uninsured idiosyncratic shocks generate bond trades, while aggregate shocks cause fluctuations in the trading price of bonds. Long bonds command a "liquidation risk premium" over short bonds, because they may have to be liquidated before maturity following a bad idiosyncratic shock precisely when their resale value is low due to the simultaneous occurrence of a bad aggregate shock. Our framework endogenously generates limited cross-sectional wealth heterogeneity among the agents (despite the presence of uninsured idiosyncratic shocks), which allows us to characterise analytically the shape of the entire yield curve, including the yields on bonds of arbitrarily long maturities. Agents desire to hedge the idiosyncratic risk together with their fear of having to liquidate long bonds at unfavourable terms imply that a greater bond supply raises the level of the yield curve, while an increase in the relative supply of long bonds raises its slope.

We analyse the term structure of interest rates in a general equilibrium model with incomplete markets, borrowing constraint, and positive net supply of government bonds. Uninsured idiosyncratic shocks generate bond trades, while aggregate shocks cause fluctuations in the trading price of bonds. Long bonds command a "liquidation risk premium" over short bonds, because they may have to be liquidated before maturity following a bad idiosyncratic shock precisely when their resale value is low due to the simultaneous occurrence of a bad aggregate shock. Our framework endogenously generates limited cross-sectional wealth heterogeneity among the agents (despite the presence of uninsured idiosyncratic shocks), which allows us to characterise analytically the shape of the entire yield curve, including the yields on bonds of arbitrarily long maturities. Agents desire to hedge the idiosyncratic risk together with their fear of having to liquidate long bonds at unfavourable terms imply that a greater bond supply raises the level of the yield curve, while an increase in the relative supply of long bonds raises its slope.

We analyse the term structure of interest rates in a general equilibrium model with incomplete markets, borrowing constraint, and positive net supply of government bonds. Uninsured idiosyncratic shocks generate bond trades, while aggregate shocks cause fluctuations in the trading price of bonds. Long bonds command a "liquidation risk premium" over short bonds, because they may have to be liquidated before maturity following a bad idiosyncratic shock precisely when their resale value is low due to the simultaneous occurrence of a bad aggregate shock. Our framework endogenously generates limited cross-sectional wealth heterogeneity among the agents (despite the presence of uninsured idiosyncratic shocks), which allows us to characterise analytically the shape of the entire yield curve, including the yields on bonds of arbitrarily long maturities. Agents' desire to hedge the idiosyncratic risk together with their fear of having to liquidate long bonds at unfavourable terms imply that a greater bond supply raises the level of the yield curve, while an increase in the relative supply of long bonds raises its slope.

We analyse the term structure of interest rates in a general equilibrium model with incomplete markets, borrowing constraint, and positive net supply of government bonds. Uninsured idiosyncratic shocks generate bond trades, while aggregate shocks cause fluctuations in the trading price of bonds. Long bonds command a "liquidation risk premium" over short bonds, because they may have to be liquidated before maturity following a bad idiosyncratic shock precisely when their resale value is low due to the simultaneous occurrence of a bad aggregate shock. Our framework endogenously generates limited cross-sectional wealth heterogeneity among the agents (despite the presence of uninsured idiosyncratic shocks), which allows us to characterise analytically the shape of the entire yield curve, including the yields on bonds of arbitrarily long maturities. Agents desire to hedge the idiosyncratic risk together with their fear of having to liquidate long bonds at unfavourable terms imply that a greater bond supply raises the level of the yield curve, while an increase in the relative supply of long bonds raises its slope.

We analyse the term structure of interest rates in a general equilibrium model with incomplete markets, borrowing constraint, and positive net supply of government bonds. Uninsured idiosyncratic shocks generate bond trades, while aggregate shocks cause fluctuations in the trading price of bonds. Long bonds command a "liquidation risk premium" over short bonds, because they may have to be liquidated before maturity following a bad idiosyncratic shock precisely when their resale value is low due to the simultaneous occurrence of a bad aggregate shock. Our framework endogenously generates limited cross-sectional wealth heterogeneity among the agents (despite the presence of uninsured idiosyncratic shocks), which allows us to characterise analytically the shape of the entire yield curve, including the yields on bonds of arbitrarily long maturities. Agents desire to hedge the idiosyncratic risk together with their fear of having to liquidate long bonds at unfavourable terms imply that a greater bond supply raises the level of the yield curve, while an increase in the relative supply of long bonds raises its slope.

We analyse the term structure of interest rates in a general equilibrium model with incomplete markets, borrowing constraint, and positive net supply of government bonds. Uninsured idiosyncratic shocks generate bond trades, while aggregate shocks cause fluctuations in the trading price of bonds. Long bonds command a "liquidation risk premium" over short bonds, because they may have to be liquidated before maturity following a bad idiosyncratic shock precisely when their resale value is low due to the simultaneous occurrence of a bad aggregate shock. Our framework endogenously generates limited cross-sectional wealth heterogeneity among the agents (despite the presence of uninsured idiosyncratic shocks), which allows us to characterise analytically the shape of the entire yield curve, including the yields on bonds of arbitrarily long maturities. Agents desire to hedge the idiosyncratic risk together with their fear of having to liquidate long bonds at unfavourable terms imply that a greater bond supply raises the level of the yield curve, while an increase in the relative supply of long bonds raises its slope.

We analyse the term structure of interest rates in a general equilibrium model with incomplete markets, borrowing constraint, and positive net supply of government bonds. Uninsured idiosyncratic shocks generate bond trades, while aggregate shocks cause fluctuations in the trading price of bonds. Long bonds command a "liquidation risk premium" over short bonds, because they may have to be liquidated before maturity following a bad idiosyncratic shock precisely when their resale value is low due to the simultaneous occurrence of a bad aggregate shock. Our framework endogenously generates limited cross-sectional wealth heterogeneity among the agents (despite the presence of uninsured idiosyncratic shocks), which allows us to characterise analytically the shape of the entire yield curve, including the yields on bonds of arbitrarily long maturities. Agents desire to hedge the idiosyncratic risk together with their fear of having to liquidate long bonds at unfavourable terms imply that a greater bond supply raises the level of the yield curve, while an increase in the relative supply of long bonds raises its slope.