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Robust control, informational frictions, and international consumption correlations

Yulei Luo (), Jun Nie () and Eric Young ()

European Economic Review, 2014, vol. 67, issue C, 1-27

Abstract: In this paper we examine the effects of model misspecification (robustness or RB) on international consumption correlations in an otherwise standard small open economy model with endogenous capital accumulation. We show that in the presence of capital mobility in financial markets, RB lowers the international consumption correlations by generating heterogeneous responses of consumption to productivity shocks across countries facing different macroeconomic uncertainty. In addition, we show that RB can also improve the model's predictions in three other moments of consumption dynamics: the relative volatility of consumption to income, the persistence of consumption, and the correlation between consumption and output. After calibrating the RB parameter using the detection error probabilities, we show that the model can explain the observed international consumption correlations as well as the other consumption moments quantitatively. Finally, we show that the main conclusions of our benchmark model do not change in an extension in which the agent cannot observe the state perfectly due to finite information-processing capacity.

Keywords: Robustness; Imperfect state observation; International consumption correlations; Consumption dynamics (search for similar items in EconPapers)
JEL-codes: D83 E21 F41 G15 (search for similar items in EconPapers)
Date: 2014
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Related works:
Working Paper: Robust Control, Informational Frictions, and International Consumption Correlations (2013) Downloads
Working Paper: Robust Control, Informational Frictions, and International Consumption Correlations (2011) Downloads
Working Paper: Robust control, informational frictions, and international consumption correlations (2010) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:67:y:2014:i:c:p:1-27

DOI: 10.1016/j.euroecorev.2013.12.007

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