Interest Rate Risk over the Life-Cycle: A General Equilibrium Approach

Billede af publikationens forside
05-09-2001
DREAM

This paper examines the consequences of introducing an idiosyncratic uncertain interest rate in a standard life-cycle model à la Auerbach and Kotlikoff (1987).

Abstract

This paper examines the consequences of introducing an idiosyncratic uncertain interest rate in a standard life-cycle model à la Auerbach and Kotlikoff (1987). Since the labor market has no uncertainty, labor earnings are used by the consumers to compensate for the risks in the capital market. The multi-period general equilibrium model introduces the possibility for consumers to adjust their labor supply ex post in response to new information becoming available (in addition to the opportunity to hedge ex ante).

Increased uncertainty causes the number of hours worked to increase, since some old agents start supplying labor to compensate the poor performance of their savings. The framework also makes it possible to quantify the value of labor supply flexibility for these old agents.