The overall objective of the thesis is to investigate needs and incentives of all income/wealth groups in order to explore ways and means to remedy the excessive economic inequality. A closer examination of individual decisions across richer and poorer households allows us to recognize conflicts of wants, needs and values and subsequently to draw recommendations for future policies. The first chapter examines households' preferences over the redistribution of wealth resources. The preferences of voting households are restricted by agents' present and future resource constraints. The wealth resources vary over the business cycle, which affects the grounds for speculations of voting households. We augment the standard Real-Business-Cycle (RBC) model by the majority voting on lump-sum redistribution employing a balanced government budget. Our findings indicate that for the usual elasticity of labor supply both transfers' level and share of output are procyclical, with the procyclicality increasing in the discrepancy between richer and poorer households. In the second chapter we analytically demonstrate that all economic agents face subsistence costs that hinder economic and financial decisions of the poor. We find that the standard two-asset portfolio-selection model with a time-invariant subsistence component in the common-across agents Stone-Geary utility function is capable of explaining qualitatively and quantitatively three empirical regularities: (i) increasing saving rates in wealth, (ii) rising risky portfolio shares with wealth, (iii) more volatile consumption growth of the richer. On the contrary, "keeping-up-with-the-Joneses" utility with a time-varying weighted mean consumption produces identical saving rates and portfolio asset shares across richer and poorer agents, failing to match the micro data. Finally, in the third chapter we use Epstein-Zin-Weil recursive preferences altered to include subsistence costs, as this form of utility function enables trade-off between stability and safety. We pursue an analytical investigation of a more complex multi-asset portfolio-choice model with perfectly insurable labor risk and no liquidity constraints and find further support of the data evidence. If households' total resources are anticipated to increase over time, poorer agents can afford to gradually escape subsistence concerns by choosing lower saving rates and accepting only minor portfolio risks as their consumption hovers close to the subsistence needs. The calibration part of the model economy shows that analytical results can quantitatively reconcile the data, too.

Stocks, Bonds, and Long-Run Consumption Risks. Bansal and Yaron (2004) show that long-run consumption risks and time-varying economic uncertainty in conjunction with recursive preferences can account for important features of equity markets. I bring the model to the term structure of interest rates and show that a calibrated version of the model can simultaneously explain properties of bonds and equities. Specifically, the model accounts for deviations from the expectations hypothesis, the upward sloping nominal yield curve, and the predictive power of the nominal yield spread. However, an estimation of the model using Simulated Method of Moments yields less convincing results and illustrates the difficulty of precisely estimating parameters of the model. Real (nominal) interest rates in the model are positively (negatively) correlated with consumption growth and real stock returns move inversely with inflation. The cyclicality of nominal interest rates and yield spreads is shown to depend on the relative values of the elasticity of intertemporal substitution and the correlation between real consumption growth and inflation. The “Fed-model” and the Changing Correlation of Stock and Bond Returns: An Equilibrium Approach. This paper presents an equilibrium model that provides a rational explanation for two features of data that have been considered puzzling: The positive relation between US dividend yields and nominal interest rates, often called the Fed-model, and the time-varying correlation of US stock and bond returns. Key ingredients are time-varying first and second moments of consumption growth, inflation, and dividend growth in conjunction with Epstein-Zin and Weil recursive preferences. Historically in the US, inflation has signaled low future consumption growth. The representative agent therefore dislikes positive inflation shocks and demands a positive risk premium for holding assets that are poor inflation hedges, such as equity and nominal bonds. As a result, risk premiums on equity and nominal bonds comove positively through their exposure to macroeconomic volatility. This generates a positive correlation between dividend yields and nominal yields and between stock and bond returns. High levels of macro volatility in the late 1970s and early 1980s caused stock and bond returns to comove strongly. The subsequent moderation in aggregate economic risk has brought correlations lower. The model is able to produce correlations that can switch sign by including the covariances between consumption growth, inflation, and dividend growth as state variables. International Bond Risk Premia. We extend Cochrane and Piazzesi (2005, CP) to international bond markets by constructing forecasting factors for bond excess returns across different countries. While the international evidence for predictability is weak using Fama and Bliss (1987) regressions, we document that local CP factors have significant predictive power. We also construct a global CP factor and provide evidence that it predicts bond returns with high R2 across countries. The local and global factors are jointly significant when included as regressors, which suggests that variation in bond excess returns are driven by country-specific factors and a common global factor. Shocks to US bond risk premia seem to be particularly important determinants for international bond premia. Motivated by these results, we estimate a parsimonious no-arbitrage affine term structure model in which risk premia are driven by one local and one global CP factor. We find that international bond risk premia are driven by a local slope factor and a world interest rate level factor.