# Risk aversion heterogeneity and the investment–uncertainty relationship

- 69 Downloads

## Abstract

We develop a dynamic macroeconomic model encompassing heterogeneity in households’ attitudes towards risk, and we allow agents to share aggregate volatility by trading safe assets. In equilibrium, when volatility increases, low-risk-averse households, who hold a long position in risky assets, perceive a higher certainty-equivalent future return on capital. The perceived yield may also increase for high-risk-averse agents, who hold riskless assets. In response to a rise in certainty-equivalent expected returns, savings decrease due to a limited willingness to substitute consumption over time. This generates a negative response of aggregate investment to an increase in systematic volatility, showing that the aggregate behavior of an heterogeneous agents economy can be different from the behavior originating from an ‘average’ representative agent. The appearance of degenerate wealth distributions is avoided by allowing the risk aversion of each household to change stochastically over time.

## Keywords

Aggregate investment Volatility Risk aversion Heterogeneity## JEL Classification

D92 E22## Notes

### Acknowledgements

For valuable comments and suggestions, I wish to thank the Editor, Giacomo Corneo, two anonymous Referees, Robert Chirinko, Luca Colombo, Marco Cozzi, Marco Maffezzoli, Hervè Roche, and Joseph Zeira. I am also grateful for the useful feedbacks from the seminar participants at the 5th Polhia Workshop, at the 26th E.E.A. Annual Conference, and at the 18th Conference on Computing in Economics and Finance. Financial support from the European Community Seventh Framework Program (FP7/2007-2013) under Socio-Economic Sciences and Humanities, Grant Agreement No. 225408, Project “Monetary, Fiscal and Structural Policies with Heterogeneous Agents (POLHIA)” is gratefully acknowledged.

## References

- Abel AB (1983) Optimal investment under uncertainty. Am Econ Rev 73:228–233Google Scholar
- Abel AB, Eberly JC (1999) The effects of irreversibility and uncertainty on capital accumulation. J Monet Econ 44:339–377CrossRefGoogle Scholar
- Angeletos G-M (2007) Uninsured idiosyncratic investment risk and aggregate saving. Rev Econ Dyn 10:1–30CrossRefGoogle Scholar
- Bansal R, Yaron A (2004) Risk for the long run: a potential resolution of asset pricing puzzles. J Finance LIX:1481–1509CrossRefGoogle Scholar
- Barro RJ (2009) Rare disasters, asset prices, and welfare costs. Am Econ Rev 99:243–264CrossRefGoogle Scholar
- Barsky RB, Juster FT, Kimball MS, Shapiro MD (1997) Preference parameters and behavioral heterogeneity an experimental approach in the health and retirement study. Q J Econ CXII:537–579Google Scholar
- Bloom N, Bond S, Van Reenen J (2007) Uncertainty and investment dynamics. Rev Econ Stud 74:391–415CrossRefGoogle Scholar
- Brunnermeier MK, Pedersen LH (2009) Market liquidity and funding liquidity. Rev Financ Stud 22:2201–2238CrossRefGoogle Scholar
- Caballero RJ (1991) On the sign of the investment-uncertainty relationship. Am Econ Rev 81:279–288Google Scholar
- Carruth A, Dickerson A, Henley A (2000) What do we know about investment under uncertainty? J Econ Surv 14:119–153CrossRefGoogle Scholar
- Chabakauri G (2013) Dynamic equilibrium with two stocks, heterogeneous investors, and portfolio constraints. Rev Financ Stud 26(12):3104–3141CrossRefGoogle Scholar
- Chen H (2010) Macroeconomic conditions and the puzzles of credit spreads and capital structure. J Finance 65:2171–2212CrossRefGoogle Scholar
- Chiappori PA, Paiella M (2011) Relative risk aversion is constant: evidence from panel data. J Eur Econ Assoc 9:1021–1052CrossRefGoogle Scholar
- Chirinko RS, Schaller H (2009) The irreversibility premium. J Monet Econ 56:390–408CrossRefGoogle Scholar
- Coen-Pirani D (2004) Effects of differences in risk aversion on the distribution of wealth. Macroecon Dyn 8:617–632Google Scholar
- Coen-Pirani D (2005) Margin requirements and equilibrium asset prices. J Monet Econ 52:449–475CrossRefGoogle Scholar
- Colacito R, Croce MM (2013) International asset pricing with recursive preferences. J Finance 68:2651–2686CrossRefGoogle Scholar
- Cozzi M (2014) Risk aversion heterogeneity, risky jobs and wealth inequality. Queen’s University, KingstonGoogle Scholar
- Craine R (1989) Risky business: the allocation of capital. J Monet Econ 23:201–18CrossRefGoogle Scholar
- Croce MM (2014) Long-run productivity risk: a new hope for production-based asset pricing? J Monet Econ 66:13–31CrossRefGoogle Scholar
- Epstein L, Zin S (1989) Substitution, risk aversion, and the temporal behavior of consumption and asset returns: a theoretical framework. Econometrica 57:937–969CrossRefGoogle Scholar
- Femminis G (2008) Risk-aversion and the investment-uncertainty relationship: the role of capital depreciation. J Econ Behav Organ 65:585–591CrossRefGoogle Scholar
- Femminis G (2014) Risk-aversion heterogeneity and the investment-uncertainty relationship: a closed-form formulation. Rivista Internazionale di Scienze Sociali 126:275–300Google Scholar
- Fostel A, Geanakoplos J (2008) Leverage cycles and the anxious economy. Am Econ Rev 98:1211–1244CrossRefGoogle Scholar
- Ghosal V, Loungani P (2000) The differential impact of uncertainty on investment in small and large businesses. Rev Econ Stat 82:338–349CrossRefGoogle Scholar
- Greenwood J, Hercowitz Z, Huffman GW (1988) Investment, capacity utilization, and the real business cycle. Am Econ Rev 78:402–417Google Scholar
- Guiso L, Parigi G (1999) Investment and demand uncertainty. Q J Econ 114:185–227CrossRefGoogle Scholar
- Guvenen F (2006) Reconciling conflicting evidence on the elasticity of intertemporal substitution: a macroeconomic perspective. J Monet Econ 53:1451–1472CrossRefGoogle Scholar
- Guvenen F (2009) A parsimonious macroeconomic model for asset pricing. Econometrica 77:1711–1750CrossRefGoogle Scholar
- Halek M, Eisenhauer JD (2001) Demography of risk aversion. J Risk Insur 68:1–24CrossRefGoogle Scholar
- Havránek T (2015) Measuring intertemporal substitution: the importance of method choices and selective reporting. J Eur Econ Assoc 13:1180–1204CrossRefGoogle Scholar
- Hartman R (1972) The effects of price and cost uncertainty on investment. J Econ Theory 5:258–266CrossRefGoogle Scholar
- Kimball MS, Sahm CR, Shapiro MD (2008) Imputing risk tolerance from survey responses. J Am Stat Assoc 102:1028–1038CrossRefGoogle Scholar
- Kimball MS, Sahm CR, Shapiro MD (2009) Risk preferences in the PSID: individual imputations and family covariation. Am Econ Rev 99:363–368CrossRefGoogle Scholar
- Kollmann R (2015) Exchange rates dynamics with long-run risk and recursive preferences. Open Econ Rev 26:175–196CrossRefGoogle Scholar
- Krusell P, Smith A (1998) Income and wealth heterogeneity in the macroeconomy. J Polit Econ 106:867–896CrossRefGoogle Scholar
- Leahy JV, Whited TM (1996) The effect of uncertainty on investment: some stylized facts. J Money Credit Bank 28:68–83CrossRefGoogle Scholar
- Lee J, Shin K (2000) The role of a variable input in the relationship between investment and uncertainty. Am Econ Rev 90:667–680CrossRefGoogle Scholar
- Meinen P, Röhe O (2017) On measuring uncertainty and its impact on investment: cross-country evidence from the euro area. Eur Econ Rev 92:161–179CrossRefGoogle Scholar
- Necker S, Voskort A (2014) Intergenerational transmission of risk attitudes–a revealed preference approach. Eur Econ Rev 65:66–89CrossRefGoogle Scholar
- Panousi V, Papanikolaou D (2012) Investment, idiosyncratic risk and ownership. J Finance 57:1113–1148CrossRefGoogle Scholar
- Roche H (2011) Asset prices in an exchange economy when agents have heterogeneous homothetic recursive preferences and no risk free bond is available. J Econ Dyn Control 35:80–96CrossRefGoogle Scholar
- Saltari E, Ticchi D (2007) Risk aversion, intertemporal substitution, and the aggregate investment-uncertainty relationship. J Monet Econ 54:622–648CrossRefGoogle Scholar
- Sarkar S (2000) On the investment-uncertainty relationship in a real options model. J Econ Dyn Control 24:219–225CrossRefGoogle Scholar
- Stathopoulos A (2017) Asset prices and risk sharing in open economies. Rev Financ Stud 30:363–415CrossRefGoogle Scholar
- Svensson LEO (1989) Portfolio choice with non-expected utility in continuous time. Econ Lett 30:313–317CrossRefGoogle Scholar
- von Gaudecker HM, van Soest A, Wengstrom E (2011) Heterogeneity in risky choice behavior in a broad population. Am Econ Rev 101:664–694CrossRefGoogle Scholar
- Zeira J (1990) Cost uncertainty and the rate of investment. J Econ Dyn Control 14:53–63CrossRefGoogle Scholar