Seminar will be on  Wednesday 27 February 2013!!
What is the relationship between wealth inequality and asset prices? We study this question in a dynamic two-agent economy with incomplete markets. Agents face correlated labor-income risk, but there is no aggregate risk. The only asset is a Lucas tree, which is traded subject to a no-short-selling constraint. We find that asset prices are increasing in wealth inequality. The asset price is highest when the poor agent hits the no-short-selling constraint and exits the asset market. Since the asset supply of the impoverished agent dries up while the rich agent’s demand stays high, there is a surge in the asset price at this point. Furthermore, asset-price volatility is increasing in inequality. Analogous results are obtained in an economy with a short-term bond and in a production economy with capital.