Robust Permanent Income in General Equilibrium

Luo, Yulei and Nie, Jun and Young, Eric (2015): Robust Permanent Income in General Equilibrium.

Abstract

This paper provides a tractable continuous-time constant-absolute-risk averse (CARA)-Gaussian framework to quantitatively explore how the preference for robustness (RB) affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB significantly reduces the equilibrium interest rate, and reduces (increases) the relative volatility of consumption growth to income growth when the income process is stationary (non-stationary). Furthermore, we find that the welfare costs of model uncertainty are nontrivial for plausibly estimated income processes and calibrated RB parameter values. Finally, we extend the benchmark model to consider the separation of risk aversion and intertemporal substitution, incomplete information about income, and regime-switching in income growth.

• Item Type: MPRA Paper
• Language: English
• Keywords: Robustness, Model Uncertainty, Precautionary Savings, the Permanent Income Hypothesis, Low Interest Rates, Consumption Inequality, General Equilibrium.
• Subjects: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling; D - Microeconomics > D5 - General Equilibrium and Disequilibrium; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D52 - Incomplete Markets; 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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