Heterogeneity and inequality

Apparently, we live in times with unprecedented levels of inequality. To understand the severity of the problem, we propose a research agenda centered on investigating the theoretical foundations of wealth accumulation through both private means such as labor or private firms and public financial markets. To achieve this objective, we develop models aimed at exploring the repercussions of heterogeneity and nontradable wealth on asset prices and overall inequality. Our approach involves constructing models within a continuous-time overlapping generations framework that incorporates heterogeneous agents. Within this framework, we accommodate variations in income characteristics, preferences, time preferences, beliefs, and learning efficiency among agents simultaneously.

We live in times with unprecedented levels of inequality. To understand the severity of the problem we propose a research agenda concerned with theoretical underpinnings of wealth accumulation through private nontradable means, which we refer to as private Lucas trees, and the stock market and bonds. To this end, we propose to build two models to study the consequences of heterogeneity and nontradable capital or trees on asset prices and inequality. More specifically, we use a theoretical tool called fictitious completion, which practically means that an incomplete market is transferred into an equivalent complete market through adjusting the state prices or discount factor. The reason for this is because models with complete financial markets are inherently much simpler to solve. We do this in a continuous time overlapping generations model with heterogeneous agents, where for some specifications we can obtain closed form solutions for all quantities but some of the equilibrium diffusion coefficients of the price processes. Within this framework, we can simultaneously allow for heterogeneity in the characteristics of the private trees (income), preferences, time preferences, beliefs, and learning (efficiency). We then study asset pricing implications and effects on consumption and wealth dynamics if agents cannot borrow against their private trees. Next, we study how investment into the private trees propagates heterogeneity into inequality in consumption and wealth. We consider that unlocking the growth potential of a private tree requires an upfront investment. Due to heterogeneity/inequality some will not be able to make the investment. A (wealth) transfer can effectively reduce the heterogeneity but this will come at the cost of deterring some would-be investors that without the taxation to finance the transfer system actually would investment. We ask what are the asset pricing implications and effects on consumption and wealth dynamics in this setting.