Safe Assets
29 Pages Posted: 30 Mar 2015
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Safe Assets
Safe Assets
Date Written: September 17, 2014
Abstract
A safe asset is one whose real value is insulated from shocks, including declines in GDP associated with rare macroeconomic disasters. However, in a Lucas-tree world, the aggregate risk is given by the specified process for GDP and cannot be altered by the creation of safe assets. Therefore, in the equilibrium of a representative-agent version of this economy, the quantity of safe assets will effectively be nil. With heterogeneity in coefficients of relative risk aversion, safe assets may take the form of private bond issues from low-risk-aversion agents to high-risk-aversion agents. I work out the quantity of safe assets, the risk-free interest rate, and the equity premium in a model with Epstein-Zin-Weil preferences, heterogeneous coefficients of relative risk aversion, and log utility (intertemporal elasticity of substitution equal to one). In one example, safe assets are around 140% of annual GDP and 6% of economy-wide assets (comprising the capitalized value of the full GDP), the risk-free rate is 1.0% per year, and the equity premium is 4.2%. In the baseline model, Ricardian equivalence holds. Added (safe) government bonds have no effect on the economy’s net quantity of safe assets or the risk-free rate and crowd out private bonds with a coefficient around -0.5.
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