Heterogeneous Risk Preferences and the Welfare Cost of Business Cycles

I study the welfare cost of business cycles in a complete-markets economy where some people are more risk averse than others. Relatively more risk-averse people buy insurance against aggregate risk, and relatively less risk-averse people sell insurance. These trades reduce the welfare cost of business cycles for everyone. Indeed, the least risk-averse people benet from business cycles. Moreover, even innitely risk-averse people suer only nite and, in my empirical estimates, very small welfare losses. In other words, when there are complete insurance markets, aggregate uctuations in consumption are essentially irrelevant not just for the average person { the surprising nding of Lucas (1987) { but for everyone in the economy, no matter how risk averse they are. If business cycles matter, it is because they aect productivity or interact with uninsured idiosyncratic risk, not because aggregate risk per se reduces welfare.