Abstract
This dissertation investigates the impact of financial frictions and imperfect access to credit in an economy characterized by idiosyncratic income risk. First, the dissertation analyses in detail the traditional case of a single-asset economy, with frictionless financial markets. Then, a two-asset economy is considered, where agents can invest in government bonds and buy housing. The research paper shows that a tightening of financial conditions (i.e. a credit crunch or a rise in intermediation costs) leads to a portfolio reallocation effect, where households with initial low wealth prefer to reduce their debt outstanding and invest in liquid bonds, in order to self-insure against adverse income shocks, while agents with high initial wealth prefer to invest in housing than bonds, as the former becomes a more profitable investment, after the negative financial shock. This, in turn, leads to an increased wealth inequality across households.