Asset pricing with economic inequality

Macroeconomic research typically uses the modelling construct of the representative agent. This helps to greatly reduce the computational complexity of models and makes it look as if macroeconomic dynamics are founded in microeconomic behaviour. However, the aggregation of individuals into a representative agent has poor theoretical foundations, and the practice hides all effects of economic inequality and heterogeneity. 

In this dissertation, I replace the representative agent in various macrofinancial models with a continuum of households that differ only in their wealth, income and means to consume. I show that these differences affect financial markets in established frameworks in the literature. I find that the macrofinancial literature can benefit from including inequality in their models to explain real-world phenomena such as the equity premium puzzle, the cross-sectional differences in stock returns and the interest rate. Moreover, I develop several new methods for analysing systems in which such heterogeneity matters.

This dissertation contains three research projects. The first is an empirical exercise, showing how the cross-sectional distribution of consumption growth can explain the cross-sectional distribution of stock returns, and how this relation can be measured using firm characteristics as an intermediary. Next, I simulate a macrofinancial model with both habit formation and non-diversifiable idiosyncratic risk, which I try to fit to historical data using the simulated generalised method of moments. Finally, I investigate how the aggregate dynamics of a Ramsey-type macroeconomic model can be dominated by a small group of households so rich that their marginal propensity to consume becomes zero.

Dissertation: https://hdl.handle.net/11370/0a9f2784-3f4b-413a-9a55-02512500c286