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Pareto Extrapolation: Bridging Theoretical and Quantitative Models of Wealth Inequality

Author

Listed:
  • Emilien Gouin-Bonenfant

    (University of California, San Diego)

  • Alexis Akira Toda

    (University of California San Diego)

Abstract
We propose a new, systematic approach for analyzing and solving heterogeneous-agent models with fat-tailed wealth distributions. Our approach exploits the asymptotic linearity of policy functions and the analytical characterization of the Pareto exponent to make the solution algorithm more transparent, efficient, and accurate with zero additional computational cost. As an application, we solve a heterogeneous-agent model that features persistent earnings and investment risk, borrowing constraint, portfolio decision, and endogenous Pareto-tailed wealth distribution. We show that relaxing the borrowing limit from 25% of annual income to 250% increases inequality by reducing the bottom 50% wealth share from 11% to 6.7% and decreases welfare by 8.2% in consumption equivalent.

Suggested Citation

  • Emilien Gouin-Bonenfant & Alexis Akira Toda, 2019. "Pareto Extrapolation: Bridging Theoretical and Quantitative Models of Wealth Inequality," 2019 Meeting Papers 152, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:152
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    2. Tjeerd de Vries & Alexis Akira Toda, 2022. "Capital and Labor Income Pareto Exponents Across Time and Space," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 68(4), pages 1058-1078, December.
    3. Ma, Qingyin & Toda, Alexis Akira, 2022. "Asymptotic linearity of consumption functions and computational efficiency," Journal of Mathematical Economics, Elsevier, vol. 98(C).
    4. Ma, Qingyin & Toda, Alexis Akira, 2021. "A theory of the saving rate of the rich," Journal of Economic Theory, Elsevier, vol. 192(C).
    5. Fischer, Thomas, 2019. "Determinants of Wealth Inequality and Mobility in General Equilibrium," Working Papers 2019:22, Lund University, Department of Economics.

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