Federal Reserve Bank of Kansas City
Research Working Paper
Robust permanent income in general equilibrium
This paper provides a tractable continuous-time constant-absolute-risk averse (CARA)-Gaussian framework to quantitatively explore how the preference for robustness (RB) affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB significantly reduces the equilibrium interest rate, and reduces the relative volatility of consumption growth to income growth when the income process is stationary. Furthermore, we find that the welfare costs of model uncertainty are nontrivial for plausibly estimated income processes and calibrated RB parameter values. Finally, we extend the benchmark model to consider the separation of risk aversion and intertemporal substitution and regime-switching in income growth.
Cite this item
Yulei Luo & Jun Nie & Eric R. Young, Robust permanent income in general equilibrium, Federal Reserve Bank of Kansas City, Research Working Paper RWP 15-14, 29 Oct 2015.
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
Keywords: Interest rates; Savings; Income; Consumption; General equilibrium
This item with handle RePEc:fip:fedkrw:rwp15-14
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