Aggregate and Idiosyncratic Risk in Macroeconomics

Since the Great Recession of 08/09, two interrelated economic phenomena challenge politics and research alike. First, the return of aggregate volatility marking the end of the Great Moderation. Second, the rise in inequality to levels last seen during the Gilded Age. A new literature has responded to this challenge by adding heterogeneity to business cycle models (HANK).

This is a major step, but the focus on certainty-equivalent solutions in aggregates restricts the interaction of both phenomena.

My research agenda aims to make ground-breaking progress by developing a new computational toolbox that allows to study the relative strength of aggregate and idiosyncratic risks and their interaction in inequality, asset returns, and business cycles.Part I develops a sparse higher-order perturbation solution for HANK models.

Smart use of the modularity of idiosyncratic and aggregate model components makes estimation feasible, which is key for quantification.Part II measures heterogeneity in the exposure to aggregate risk and quantifies its contribution inequality.

The volatility of wages, portfolio returns, and tax rates differs across the distribution, and this affects inequality via household portfolio decisions. Part III decomposes the capital premium into the parts coming from idiosyncratic and aggregate risk.

Large parts of the capital stock feature trading costs that can explain part of the equity premium, which makes the equity premium puzzle less severe.Part IV examines the cost of business cycles and novel benefits of stabilization policies.

By reducing aggregate risk, policy allows households to hold less liquid portfolios and increase investment into capital.Part II-IV contribute to fundamental questions in macroeconomics: the welfare costs of business cycles, the benefits of fiscal vs. monetary stabilization, and the drivers of inequality and asset returns.

My agenda is ambitious, but the importance of the questions imply an extremely high return.