Consumption, Market Price of Risk, and Wealth Accumulation under Induced Uncertainty

Luo, Yulei and Young, Eric (2013): Consumption, Market Price of Risk, and Wealth Accumulation under Induced Uncertainty.

Abstract

In this paper we examine implications of model uncertainty due to robustness (RB) for consumption-saving, market price of uncertainty, and aggregate wealth accumulation under limited information-processing capacity (rational inattention or RI) in an otherwise standard permanent income model. We first solve the robust permanent income models with inattentive consumers and show that RI by itself creats an additional demand for robustness that leads to higher ¡°induced uncertainty¡± facing consumers. Second, we explore how the induced uncertainty composed by (i) model uncertainty due to RB and (ii) state uncertainty due to RI, affects consumption-saving decisions and the market price of uncertainty. Particurly, we find that induced uncertainty can better explain the observed market price of uncertainty. Furthermore, we explore the observational equivalence between RB and risk-sensitivity (RS) in this filtering problem. Finally, we evaluate the importance of induced uncertainty and fundamental uncertainty in determining equilibrium aggregate wealth.

• Item Type: MPRA Paper
• Language: English
• Keywords: Robust Filtering, Rational Inattention, Observational Equivalence, Induced Uncertainty, Market Prices of Uncertainty, Wealth Accumulation
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search ; Learning ; Information and Knowledge ; Communication ; Belief ; Unawareness; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E21 - Consumption ; Saving ; Wealth

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