THE RISK-FREE RATE IN HETEROGENEOUS-AGENT INCOMPLETE-INSURANCE ECONOMIES

Why has the average real risk-free interest rate been less than one percent'' The question is motivated by the failure of a class of calibrated representative-agent economies to explain the average return to equity and risk-free debt. I construct an economy where agents experience uninsurable idiosyncratic endowment shocks and smooth consumption by holding a risk-free asset. I calibrate the economy and characterize equilibria computationally. With a borrowing constraint of one year's income, the resulting risk-free rate is more than one percent below the rate in the comparable representative-agent economy.