Search Results
Working Paper
Robustness, information-processing constraints, and the current account in small open economies
We examine the effects of two types of informational frictions, robustness (RB) and nite information-processing capacity (called rational inattention or RI) on the current account, in an otherwise standard intertemporal current account (ICA) model. We show that the interaction of RB and RI has the potential to improve the model?s predictions on the joint dynamics of the current account and income: (i) the contemporaneous correlation between the current account and income, (ii) the volatility and persistence of the current account in small open emerging and developed economies. In addition, we ...
Working Paper
Production and Inventory Dynamics under Ambiguity Aversion
We propose a production-cost smoothing model with Knightian uncertainty due to ambiguity aversion to study the joint behavior of production, inventories, and sales. Our model can explain four facts that previous studies find difficult to account for simultaneously: (i) the high volatility of production relative to sales, (ii) the low ratio of inventory-investment volatility to sales volatility, (iii) the positive correlation between sales and inventories, and (iv) the negative correlation between the inventory-to-sales ratio and sales. We find that the stock-out avoidance motive (Kahn 1987) ...
Working Paper
Model uncertainty, state uncertainty, and state-space models
This technical paper considers ways to capture uncertainty in the context of so-called "state-space" models. ; State-space models are powerful tools commonly used in macroeconomics, international economics, and finance. State-space models can generate estimates of an underlying, ultimately unobserved variable?such as the natural rate of unemployment?based on the movements of other variables that are observed and have some relationship to the unobserved variable. The paper shows how several macroeconomic models can be mapped to the state-space framework, thus helping quantify uncertainty ...
Working Paper
Robust control, informational frictions, and international consumption correlations
In this paper we examine the effects of two types of information imperfections, robustness (RB) and nite information-processing capacity (called rational inattention or RI), on international consumption correlations in an otherwise standard small open economy model. We show that in the presence of capital mobility in nancial markets, RB lowers the international consumption correlations by generating heterogeneous responses of consumption to income shocks across countries facing different macroeconomic uncertainty. However, the calibrated RB model cannot explain the observed consumption ...
Working Paper
Ignorance, Uncertainty, and Strategic Consumption-Portfolio Decisions
This paper constructs a recursive utility version of a canonical Merton (1971) model with uninsurable labor income and unknown income growth to study how the interaction between two types of uncertainty due to ignorance affects strategic consumption-portfolio rules and precautionary savings. Specifically, after solving the model explicitly, we theoretically and quantitatively explore (i) how these ignorance-induced uncertainties interact with intertemporal substitution, risk aversion, and the correlation between the equity return and labor income, and (ii) how they jointly affect strategic ...
Working Paper
Attention Allocation and Heterogenous Consumption Responses
Recessions often have detrimental effects on both employment and equity returns, forcingindividuals to make decisions about how to balance risks to their labor and capital income.In this paper, we study how individuals allocate their limited attention between capital income and labor income risks in a two-period consumption-saving model with recursive utility.Specifically, we examine how the optimal attention and consumption-saving decisions are influenced by individuals’ attention capacity, wealth endowments, income risks, and preferencesfor risk and time. We show that our model can ...
Working Paper
Wealth in the Utility Function and Consumption Inequality
Wealth in the utility function (WIU) has been increasingly used in macroeconomic modelsand this specification can be justified by a few theories such as Max Weber’s (1904-05, German; 1958) theory on “spirit of capitalism.” We incorporate the WIU into a general equilibriumconsumption-portfolio choice model to study the implications of the WIU for consumption inequality, equilibrium interest rate, and equity premium—an unexplored area in the literature.Our general equilibrium framework features recursive exponential utility, uninsurable labor risks,and multiple assets and can deliver ...
Working Paper
Sticky information diffusion and the inertial behavior of durable consumption
A leading theory of consumption behavior is that consumers choose their consumption based only on their expected total lifetime income. This theory is called the permanent income hypothesis. According to this theory, consumers should adjust their consumption if they experience a change that affects their expected lifetime income, such as through an unexpected change in employment that affects their expected earnings going forward. One challenge for this theory is that the empirical evidence on consumer spending decisions for durable and nondurable goods does not match the implications of this ...
Working Paper
Model uncertainty and intertemporal tax smoothing
In this paper we examine how model uncertainty due to the preference for robustness (RB) affects optimal taxation and debt structure in the Barro tax-smoothing model (1979). We first study how the government spending shocks are absorbed in the short run by varying taxes or through debt under RB. Furthermore, we show that introducing RB can improve the model?s predictions by generating (i) the observed relative volatility of the changes in tax rates to government spending and (ii) the observed comovement between government deficits and spending, and (iii) more consistent behavior of government ...
Working Paper
Growth and Welfare Gains from Financial Integration Under Model Uncertainty
We build a robustness (RB) version of the Obstfeld (1994) model to study the effects of financial integration on growth and welfare. Our model can account for the empirically observed heterogeneity in the relationship between growth and volatility for different countries. The calibrated model shows that financial integration leads to significantly larger gains in growth and welfare for advanced countries than developing countries, with some developing countries experiencing growth and welfare loss in financial integration. Our analytical solutions help uncover the key mechanisms by which this ...