Survey respondents disagree strongly about the dispersion of future returns and, increasingly, macroeco-nomic uncertainty. Such disagreement about risk may raise asset prices when collateralized debt prod-ucts allow investors to realize perceived gains from trade. Investors who expect low volatility in collateralcash-flow appreciate senior debt as riskless. Those who expect high volatility, in contrast, value the up-side potential in junior debt or equity claims. We show how such self-selection may have had a sizeableeffect on the prices of RMBS and CDOs before the crisis, as investors disagreed about the volatility ofaggregate economic conditions and their importance for default rates in collateral pools.

We document systematic differences in macroeconomic expectations across U.S. households and rationalize our findings with a theory of information choice. We embed this theory into an incomplete-markets model with aggregate risk. Our model is quantitatively consistent with the pattern of expectation heterogeneity in the data. Relative to a full-information counterpart, our model implies substantially increased macroeconomic volatility and inequality. We show through the example of a wealth tax that neglecting the information channel leads to erroneous conclusions about the effects of policies. While in the model without information choice a wealth tax reduces wealth inequality, in our framework it reduces information acquired in the economy, leading to increased volatility and higher wealth inequality in equilibrium.

We adapt the wage contracting structure in Chari (1983) to a dynamic, balanced-growth settingwith re-contracting à la Calvo (1983). The resulting wage-rigidity framework delivers a model verysimilar to that in Jaimovich and Rebelo (2009), with their habit parameter replaced by ourprobability of wage-contract resetting. That is, if wage contracts can be reset very frequently, laborsupply behaves in accordance with King et al. (1988) preferences, whereas if they are sticky for along time, we obtain the setting in Greenwood et al. (1988), thus allowing significant responses ofhours to wage changes.

Solutions to macroeconomic models with wealth inequality and aggregate shocks often rely on theassumption of limited but common information among households. We show that this assumptionis inconsistent with rational information choice for plausible information costs. To do so, we embedinformation choice into the workhorse heterogeneous-agent model with aggregate risk (Krusell andSmith, 1998). First, we demonstrate that the benefits of acquiring more precise information aboutthe state of the economy depend crucially on household wealth. Second, we show that suchheterogeneous incentives to acquire information combine with the strategic substitutability ofsavings choices to imply that equilibria in which households acquire the same information do notexist for plausible information costs. Finally, we document that a representative-agent equilibriummay not exist even in the absence of exogenous sources of wealth heterogeneity.

We quantitatively evaluate a model of insurance with limited commitment where the requirement that contracts be immune to deviations by subcoalitions makes group size endogenous, as proposed by Genicot and Ray. We compare the model's predictions to panel data from rural Indian villages. Apart from predicting a realistic degree of insurance, the model captures the evidence along two new dimensions: First, the largest coalition-proof groups are substantially smaller than typical villages. Second, with strong insurance in small groups, individual consumption responds symmetrically to income rises and falls, while alternative models predict strong counterfactual asymmetry.

We quantify the unemployment-risk channel in business-cycle fluctuations,whereby an initial contractionary shock is amplified through workers reducingtheir demand in fear of unemployment. We document two stylized facts onhow unemployment and unemployment risk respond to identified demand andsupply shocks in US data. First, separation and job-finding rates play similarimportant roles in accounting for the overall unemployment response. Second,separations are more important early on, while job-finding rates respond with alag. We show how a tractable heterogeneous-agent new-Keynesian model witha frictional labor market matches both facts once we include endogenous separations and sluggish vacancy creation. Relative to a model with exogenous separations and free entry, our framework attributes almost twice as large a shareof output fluctuations to the inefficient unemployment-risk channel, and thusgives a larger role to stabilization policy.

How do business cycle fluctuations affect the ability of households to smooth consumption against idiosyncratic shocks? To answer this question, we first document that, in U.S.\ micro-data, individual consumption reacts more to income changes in booms. Standard incomplete markets models, in contrast, where individuals borrow and save to smooth consumption, predict a lower sensitivity of consumption to individual income changes during times of high output. This motivates us to consider an alternative environment where financial frictions are endogenous and arise from lack of contract enforcement, whose business cycle properties have so far not been studied. We show analytically that this model is consistent with a wide variety of cyclical patterns of insurance. In a quantitative application with unemployment risk, we show that the response of individual consumption to job losses differs strongly between times of high and low output, and identify the conditions under which it is procyclical, as in the data.

We present a tractable heterogeneous-agent version of the New Keynesian model that allows us to study the interaction between inequality and monetary policy. Though formulated as a precautionary-saving model à la Huggett–Aiyagari, its reduced form is a two-agent model with a highly concentrated wealth distribution. When prices are sticky and wages flexible, as in the textbook representative-agent model, monetary policy affects the distribution of consumption, but has no effect on output as workers choose not to change their hours worked in response to wage movements. This highlights a transmission mechanism of the textbook model that we find implausible: in response to a monetary stimulus, the representative worker’s labor supply is greatly affected by the profits she receives. First, the lower profits induced by higher wages raise labor supply through a wealth effect and, secondly, the mere presence of profits reduces the negative income effect of a wage rise. When wages are rigid, in contrast, our model exhibits plausible responses of output and hours worked to monetary policy shocks.

An additional reason for the structured finance boom of the 2000s may have been disagreement about default risk of collateral assets. When risk-neutral investors disagree about average default probabilities, structuring collateral cash flow raises prices by concentrating optimists' demand on risky tranches. With disagreement about default correlation, low-correlation investors believe in diversification and pay high prices for senior tranches they deem riskless. High-correlation investors value junior tranches they expect to pay whenever aggregate conditions are good. Risk aversion and short selling through credit default swaps reduce the prices of both pass-through and structured securitizations but may increase the return to tranching.

We study consumption risk sharing when individual income shocks are persistent and not publicly observable, and individuals can default on contracts at the price of financial autarky. We find that, in contrast to a model where the only friction is limited enforcement, our model has observable implications that are similar to those of an Aiyagari (1994) self-insurance model and therefore broadly consistent with empirical observations. However, some of the implied effects of changes in policy or the economic environment are noticeably different in our model compared to self-insurance.