Inequality Risk Premia

Assets that hedge against systematic shocks to the consumption distribution may carry a risk premium which aggregates differing preferences for redistribution. This paper explores that risk premium theoretically and empirically. Using a long time-series of U.S. income inequality, I find that differing exposure to inequality risk is a significant factor in explaining differences in asset returns. The return premium is negative: the market pays higher prices for assets that hedge against increased inequality. This is consistent with the prediction of an incomplete-markets model incorporating a utility specification with both comparative and noncomparative consumption quot;goods'' when the weight on the former is large. Moreover, the model implies that the time-series properties of the premium can be used to identify the substitutability of these two sources of utility. There is evidence that the magnitude of the (negative) inequality risk premium is countercyclical. This suggests that agents care more about cross-sectional comparisons when they are worse off, and hence that consumption externalities may be alleviated by growth