ECB Lamfalussy Research Fellowship 2022

(Job market paper)

Do rising asset prices make savers better off? The traditional way to answer this question is to study wealth inequality. This paper studies the effect of fundamental drivers of rising asset prices (a rise in patience, an increase in productivity, financial innovation, or a bubble driven by financial frictions) on top welfare inequality between super rich entrepreneurs (borrowers) and savers through leverage. Using a model with financial frictions, idiosyncratic risks, and unequal capital income, I show that different fundamental drivers of rising asset prices move wealth inequality and savers' welfare in different directions by affecting leverage differently. Given the rising asset prices, falling risk-free rates, and rising top wealth inequality observed in the U.S., the model suggests that the rising patience of the super-rich is the main driver of the trend, and therefore savers are worse off.

This paper provides a theory of sovereign bond safety where country size interacting with financial friction is the key determinant. A larger country spills over consumption and domestic risk through international trade and financial market to a smaller country, which improves the hedging benefit of the larger country's bond globally: country size spillover effect. Financial friction drains international financial market liquidity and creates endogenous systemic risk instability between normal times and crisis. In crisis, international risk-sharing is limited and domestic risk is amplified, which improves the hedging benefit of domestic bond: financial friction effect. The larger country's bond is a global safe asset when country size spillover effect dominates financial friction effect. The model explains the uncovered interest rate parity (UIP) violation, UIP reversal, flight-to-safety, sovereign bond covered interest rate parity (CIP) deviations and convenience yields.