 Induced uncertainty, market price of risk, and the dynamics of consumption and wealthYulei Luo () and Eric Young Journal of Economic Theory, 2016, vol. 163, issue C, 1-41 Abstract: In this paper we examine the implications of model uncertainty or robustness (RB) for consumption and saving and the market price of uncertainty under limited information-processing capacity (rational inattention or RI). First, we show that RI by itself creates an additional demand for robustness that leads to higher “induced uncertainty” facing consumers. Second, if we allow capacity to be elastic, RB increases the optimal level of attention. Third, we explore how the induced uncertainty composed of (i) model uncertainty due to RB and (ii) state uncertainty due to RI, affects consumption and wealth dynamics, the market price of uncertainty, and the welfare losses due to incomplete information. We find that induced uncertainty can better explain the observed consumption-income volatility and market price of uncertainty – low attention increases the effect of model misspecification. Keywords: Robust control and filtering; Optimal inattention; Induced uncertainty; Market prices of uncertainty; Consumption and income volatility (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:163:y:2016:i:c:p:1-41 DOI: 10.1016/j.jet.2016.01.003 Access Statistics for this article Journal of Economic Theory is currently edited by A. Lizzeri and K. Shell More articles in Journal of Economic Theory from Elsevier |
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