Welfare cost of business cycles in economies with individual consumption risk

Martin Ellison and Thomas Sargent

No 25/2012, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: The welfare cost of random consumption fluctuations is known from De Santis (2007) to be increasing in the level of individual consumption risk in the economy. It is also known from Barillas et al. (2009) to increase if agents in the economy care about robustness to model misspecification. In this paper, we combine these two effects and calculate the cost of business cycles in an economy with consumers who face individual consumption risk and who fear model misspecification. We find that individual risk has a greater impact on the cost of business cycles if agents already have a preference for robustness. Correspondingly, we find that endowing agents with concerns about a preference for robustness is more costly if there is already individual risk in the economy. The combined effect exceeds the sum of the individual effects.

Keywords: Cost of Business Cycles; Idiosyncratic Risk; Model Uncertainty; Robustness (search for similar items in EconPapers)
JEL-codes: D81 E32 E63 (search for similar items in EconPapers)
Date: 2012
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Related works:
Working Paper: Welfare Cost of Business Cycles in Economies with Individual Consumption Risk (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofrdp:rdp2012_025

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