Accounting for the U.S. Wealth Inequality with Heterogeneous Portfolio Performance

Abstract

This paper accounts for the U.S. wealth inequality; we study ex ante identical households that face uninsured idiosyncratic shocks to their labor endowments and portfolio performances. The approach is motivated by numerous data sources indicating there is a great deal of inequality in households portfolio performance due to the under-diversification in portfolio equity. Thus, assuming all households face only aggregate risk in their portfolios (which is the common approach taken in the literature) may be too rough an approximation and lead to biased results about wealth accumulation. Our model results closely account for the U.S. wealth and earnings inequality, especially the top thin tails in the Lorenz curves. Collectively, incorporating the stock return inequality changes our inference about stochastic growth models, particularly those which account for the U.S. wealth distribution.

Keywords: Asset pricing, portfolio choice, heterogeneous agents and Wealth redistribution

JEL Classification: D31, G12