M. Huggett, THE RISK-FREE RATE IN HETEROGENEOUS-AGENT INCOMPLETE-INSURANCE ECONOMIES, Journal of economic dynamics & control, 17(5-6), 1993, pp. 953-969
Why has the average real risk-free interest rate been less than one pe
rcent'' The question is motivated by the failure of a class of calibra
ted representative-agent economies to explain the average return to eq
uity and risk-free debt. I construct an economy where agents experienc
e uninsurable idiosyncratic endowment shocks and smooth consumption by
holding a risk-free asset. I calibrate the economy and characterize e
quilibria computationally. With a borrowing constraint of one year's i
ncome, the resulting risk-free rate is more than one percent below the
rate in the comparable representative-agent economy.