This paper introduces new techniques to obtain a closed-form household-by-household characterization of the equilibrium distribution of wealth in a model in which nitely lived heterogeneous households face uninsurable idiosyncratic investment risk. A central result is that the extent of inequality is determined entirely by two factors. The fi rst factor, household exposure to idiosyncratic investment risk, increases inequality.
The second factor, the reversion rates of household wealth (a measure of mean reversion), decreases inequality. We show that economic mobility is decreasing in inequality and increasing in the reversion rates, a result that is consistent with recent empirical observations about the geographic variation in mobility that exists both domestically and internationally. Our approach allows us to examine the implications of increased market completeness in the form of a risk-sharing subgroup of households. We show that a risk-sharing subgroup rises or falls in the equilibrium wealth distribution depending on the level of inequality, and that its presence raises welfare and the rate of wealth accumulation for all households in the economy.

Ricardo T. Fernholz
Assistant Professor of Economics, Robert Day School of Economics and Finance, Claremont McKenna College.