Distribution of Wealth and Incomplete Markets: Theory and Empirical Evidence

This paper analyzes the equilibrium distribution of wealth in an economy where firms’ productivities are subject to idiosyncratic shocks, returns on factors are determined in competitive markets, dynasties have linear consumption functions and government imposes taxes on capital and labour incomes and equally redistributes the collected resources to dynasties. The equilibrium distribution of wealth is explicitly calculated and its shape crucially depends on market incompleteness. With incomplete markets it follows a Paretian law in the top tail and the Pareto exponent depends on the saving rate, on the net return on capital, on the growth rate of population and on portfolio diversification. On the contrary, the characteristics of the labour market mostly a effects the bottom tail of the distribution of wealth. The analysis also suggests a positive relationship between growth and wealth inequality. The theoretical predictions find a corroboration in the empirical evidence of Italy and United States in the period 1987-2004.