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Abstract:

We extend the Huggett model to consider recursive preferences in continuous time. We then analyze the role of relative risk aversion (RRA) and elasticity of intertemporal substitution (EIS) in determining the equilibrium interest rate and the stationary wealth and consumption distributions. We show that EIS plays a crucial role in shaping wealth and consumption distribution at the aggregate and agent-type levels, while RRA plays a marginal role. Additionally, EIS has strong effects on interest rate and leverage compared to RRA. Our model is characterized by wealth and income heterogeneity among agents, incomplete markets, and a quantitative separation between RRA and EIS, providing a baseline framework for macro-finance models.

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