Essays on dynamic economies with frictions.

Abstract

This dissertation consists of two essays. In the first essay we analyze the role of frictions in the pattern of intergenerational transfers. Simple theories about why parents give money to their children fail to explain a central puzzle in inter-generational transfers: While they are alive, parents give more money to their poorer children. When they leave bequests, most parents divide money equally among their children regardless of their income. We develop a model in which parents cannot observe their children's productivity. We show that parents differentiate between gifts and bequests to help their children more effectively. Parents are able to use future income uncertainty to provide the children with more help and better incentives. We show that in our model poor children get more in gifts than richer children and bequests are equal for all children under some parameterizations. We build a richer quantitative model to compare the explanatory power of our model as compared with a frictionless environment when parameters are picked to match US income and wealth data. We find that our model significantly reduces the costs needed to rationalize equal division of bequests relative to a frictionless environment. In the second essay we analyze the role of financial frictions in high asset price volatility. Existing dynamic general equilibrium models have have not been fully successful at explaining the high volatility of asset prices that we observe in the data. We construct a general equilibrium model with heterogeneous firms and financial frictions that addresses this issue. In each period only a fraction of firms can start new projects, which cannot be fully financed externally due to a financial constraint. We allow the tightness of the financial constraint to vary over time. Fluctuations in the tightness of the financial constraint result in fluctuations in the supply of equity and consequently in the price of equity. We calibrate the model to the U.S. data to assess the quantitative importance of fluctuations in the tightness of the financial constraint. The model generates a volatility in the price of equity comparable to the aggregate stock market while also fitting key aspects of the behavior of aggregate quantities.