With Jess Benhabib and Jianjun Miao. Quantitative Economics, 2024.
This paper develops a tractable heterogeneous-agent model to explain why wealth is much more concentrated than earnings. Households hold liquid bonds and illiquid capital, while capital income is subject to rare positive jumps, interpreted as returns to technological innovation or R&D. These jumps allow a small group of households to accumulate very large fortunes, generating a wealth distribution with a substantially heavier right tail than the distribution of labor income.
Large but infrequent returns to capital provide a distinct source of wealth inequality. Households receiving exceptional returns from innovation or R&D can move rapidly into the top of the wealth distribution, even when their labor-income risk is much less dispersed.
Capital-income risk alone need not produce greater wealth skewness. The model shows that the illiquidity of capital and the higher moments of the jump-size distribution determine precautionary saving, wealth skewness, and the thickness of the upper tail.
The stationary wealth distribution has an exponential rather than a literal power-law tail. Nevertheless, exponential and Pareto tails can be nearly indistinguishable in realistically sized samples. The calibrated model reproduces the extreme top of the US wealth distribution while also matching wealth shares elsewhere in the distribution reasonably well.
This paper connects heterogeneous-agent macroeconomics with research on capital-income risk, innovation, entrepreneurial wealth, illiquid portfolios, and the statistical properties of wealth tails. It shows that explaining observed top wealth concentration does not necessarily require a theoretically Pareto-tailed wealth distribution.