Discussion paper

DP9636 Safety Traps

Fear of risk provides a rationale for protracted economic downturns. We develop a real business cycle model where investors with decreasing relative risk aversion choose between a risky and a safe technology that exhibit decreasing returns. Because of a feedback effect from the interest rate to risk aversion, two equilibria can emerge: a standard equilibrium and a ``safe'' one in which investors invest in safer assets. We refer to the dynamics of this second equilibrium as a safety trap because it is self-reinforcing as investors accumulate more wealth and show it to be consistent with Japan's lost decade.

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Citation

Benhima, K (2013), ‘DP9636 Safety Traps‘, CEPR Discussion Paper No. 9636. CEPR Press, Paris & London. https://cepr.org/publications/dp9636