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Robust Control, Informational Frictions, and International Consumption Correlations

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

No 212013, Working Papers from Hong Kong Institute for Monetary Research

Abstract: In this paper we examine the effects of model misspecification (robustness or RB) on international consumption correlations in two otherwise standard small open economy models: one with perfect state observation and the other with imperfect state observation. 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 income shocks across countries facing different macroeconomic uncertainty. However, the calibrated RB model with perfect state observation cannot explain the observed consumption correlations quantitatively. We then show that the RB model with imperfect state observation is capable of matching the behavior of international consumption quantitatively via two channels: (i) the gradual response to income shocks that increases the correlations and (ii) the presence of the common noise shocks that reduce the correlations.

Keywords: Robustness; Imperfect State Observation; International Consumption Correlations (search for similar items in EconPapers)
JEL-codes: D83 E21 F41 G15 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2013-11
New Economics Papers: this item is included in nep-dge and nep-opm
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Related works:
Journal Article: Robust control, informational frictions, and international consumption correlations (2014) 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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