Robust permanent income in general equilibrium

Yulei Luo (), Jun Nie and Eric Young

No RWP 15-14, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: 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.

Keywords: Interest rates; Savings; Income; Consumption; General equilibrium (search for similar items in EconPapers)
JEL-codes: C61 D81 E21 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2015-10-29
New Economics Papers: this item is included in nep-dge, nep-mac and nep-upt
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Citations: View citations in EconPapers (1)

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Working Paper: Robust Permanent Income in General Equilibrium (2015)
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DOI: 10.18651/RWP2015-14

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