Safe Assets

Robert J. Barro, Andrew Mollerus

NBER Working Paper No. 20652
Issued in October 2014
NBER Program(s):   AP   ME

A safe asset's real value is insulated from shocks, including declines in GDP from rare macroeconomic disasters. However, in a Lucas-tree world, the aggregate risk is given by the process for GDP and cannot be altered by the creation of safe assets. Therefore, in the equilibrium of a representative-agent version of this economy, the quantity of safe assets will effectively be nil. With heterogeneity in coefficients of relative risk aversion, safe assets may take the form of private bond issues from low-risk-aversion to high-risk-aversion agents. The model assumes Epstein-Zin/Weil preferences and log utility (intertemporal elasticity of substitution equal to one) and achieves stationarity by having agents die off and be replaced. We derive the steady-state quantity of safe assets and the shares of each agent in equity ownership and overall assets. In a baseline case, the risk-free rate is 1.0% per year, the unlevered equity premium is 4.2%, and the quantity of safe assets ranges up to 10% of economy-wide assets (comprising the capitalized value of the full GDP). A disaster shock leads to an extended period in which the share of wealth held by the low-risk-averse agent and the risk-free rate are low but rising and the ratio of safe to total assets is high but falling. In the baseline model, Ricardian Equivalence holds in that added government bonds have no effect on the risk-free rate and the net quantity of safe assets. The implied crowding-out coefficient for private bonds with respect to public bonds is around -0.5, a value found in some existing empirical studies.