| By: |
Joseph Kopecky (Department of Economics, Trinity College Dublin);
Alan M. Taylor (Department of Economics and Graduate School of Management, University of California, Davis) |
| Abstract: |
Population aging has been linked to global declines in real interest rates. A
similar trend is seen for equity risk premia, which are on the rise. An
existing literature can explain part of the declining trend in safe rates
using demographics, but has no mechanism to speak to trends in relative
returns on different assets. We calibrate a heterogeneous agent life-cycle
model with equity markets and aggregate risk, and we show that aging
demographics can simultaneously account for both the majority of a downward
trend in the risk free rate, while also increasing the return premium attached
to risky assets. This is because the life-cycle savings dynamics that have
been well documented exert less pressure on risky assets as older households
shift away from risk. Under reasonable calibrations we find declines in the
safe rate that are considerably larger than most existing estimates between
the years 1990 and 2017. We are also able to account for most of the rise in
the equity risk premium. Projecting forward to 2050 we show that persistent
demographic forces will continue to push the risk free rate further into
negative territory, while the equity risk premium remains elevated. |
| Keywords: |
life-cycle model, demographics, rates of return, safe assets, risky assets, secular stagnation |
| JEL: |
E21 E43 G11 J11 |
| Date: |
2020–03 |
| URL: |
http://d.repec.org/n?u=RePEc:tcd:tcduee:tep1220&r= |