Risk aversion heterogeneity and the investment–uncertainty relationship

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.