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The Role of Consumer's Risk Aversion on Price Rigidity

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  • Sergio A. Lago Alves
  • Mirta N. S. Bugarin

Abstract

This paper aims to contribute to the research agenda on the sources of price rigidity. Based on broadly accepted assumptions on the behavior of economic agents, we show that firms’ competition can lead to the adoption of sticky prices as a sub-game perfect equilibrium strategy to optimally deal with consumers’ risk aversion, even if firms have no adjustment costs. To this end, we build a model economy based on consumption centers with several complete markets and relax some traditional assumptions used in standard monetary policy models by assuming that households have imperfect information about the inefficient time-varying cost shocks faced by the .rms. Furthermore, we assume that the timing of events is such that, at every period, consumers have access to the actual prices prevailing in the market only after choosing a particular consumption center. Since such choices under uncertainty may decrease the expected utilities of risk-averse consumers, competitive firms adopt some degree of price stickiness in order to minimize the price uncertainty and "attract more customers".

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Bibliographic Info

Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 121.

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Date of creation: Nov 2006
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Handle: RePEc:bcb:wpaper:121

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  1. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  2. Jeffery D. Amato & Thomas Laubach, 1999. "Monetary policy in an estimated optimization-based model with sticky prices and wages," Research Working Paper 99-09, Federal Reserve Bank of Kansas City.
  3. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  4. Marco Bonomo & René Garcia, 2001. "The macroeconomic effects of infrequent information with adjustment costs," Canadian Journal of Economics, Canadian Economics Association, vol. 34(1), pages 18-35, February.
  5. Almeida Neto, Heitor Vieira de & Bonomo, Marco Antônio Cesar, 1999. "Optimal State-Dependent Rules, Credibility, and Inflation Inertia," Economics Working Papers (Ensaios Economicos da EPGE) 349, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  6. Debreu,Gerard Introduction by-Name:Hildenbrand,Werner, 1986. "Mathematical Economics," Cambridge Books, Cambridge University Press, number 9780521335614.
  7. Mark J. Zbaracki & Mark Ritson & Daniel Levy & Shantanu Dutta & Mark Bergen, 2004. "Managerial and Customer Costs of Price Adjustment: Direct Evidence from Industrial Markets," The Review of Economics and Statistics, MIT Press, vol. 86(2), pages 514-533, May.
  8. Simon Hall & Mark Walsh & Anthony Yates, 1997. "How do UK companies set prices?," Bank of England working papers 67, Bank of England.
  9. Sergio A. L. Alves & Waldyr D. Areosa, 2005. "Targets and Inflation Dynamics," Working Papers Series 100, Central Bank of Brazil, Research Department.
  10. Caplin, A. & Leahy, J., 1989. "State-Dependent Pricing And The Dynamics Of Money And Output," Discussion Papers 1989_32, Columbia University, Department of Economics.
  11. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
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Cited by:
  1. Ricardo Schechtman, 2007. "Joint Validation of Credit Rating PDs under Default Correlation," Working Papers Series 149, Central Bank of Brazil, Research Department.
  2. Gilneu F. A. Vivan & Benjamin M. Tabak, 2007. "A New Proposal for Collection and Generation of Information on Financial Institutions' Risk: the case of derivatives," Working Papers Series 133, Central Bank of Brazil, Research Department.
  3. Benjamin M. Tabak, 2006. "The Dynamic Relationship between Stock Prices and Exchange Rates: evidence for Brazil," Working Papers Series 124, Central Bank of Brazil, Research Department.
  4. Solange Gouvea, 2007. "Price Rigidity in Brazil: Evidence from CPI Micro Data," Working Papers Series 143, Central Bank of Brazil, Research Department.
  5. Barbara Alemanni & José Renato Haas Ornelas, 2006. "Herding Behavior by Equity Foreign Investors on Emerging Markets," Working Papers Series 125, Central Bank of Brazil, Research Department.
  6. Sergio Rubens Stancato de Souza & Benjamin M. Tabak & Daniel O. Cajueiro, 2007. "Long-Range Dependence in Exchange Rates: the case of the European Monetary System," Working Papers Series 131, Central Bank of Brazil, Research Department.
  7. Arnildo da Silva Correa & André Minella, 2006. "Nonlinear Mechanisms of the Exchange Rate Pass-Through: a Phillips curve model with threshold for Brazil," Working Papers Series 122, Central Bank of Brazil, Research Department.
  8. Marcelo Y. Takami & Benjamin M. Tabak, 2007. "Evaluation of Default Risk for The Brazilian Banking Sector," Working Papers Series 135, Central Bank of Brazil, Research Department.

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