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Welfare cost of business cycles in economies with individual consumption risk

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Author Info

  • Ellison, Martin

    ()
    (University of Oxford)

  • Sargent, Thomas J.

    ()
    (New York University)

Abstract

The welfare cost of random consumption fluctuations is known from De Santis (2007) to be increasing in the level of individual consumption risk in the economy. It is also known from Barillas et al. (2009) to increase if agents in the economy care about robustness to model misspecification. In this paper, we combine these two effects and calculate the cost of business cycles in an economy with consumers who face individual consumption risk and who fear model misspecification. We find that individual risk has a greater impact on the cost of business cycles if agents already have a preference for robustness. Correspondingly, we find that endowing agents with concerns about a preference for robustness is more costly if there is already individual risk in the economy. The combined effect exceeds the sum of the individual effects.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/BoF_DP_1225.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 25/2012.

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Length: 19 pages
Date of creation: 30 Jul 2012
Date of revision:
Handle: RePEc:hhs:bofrdp:2012_025

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Related research

Keywords: cost of business cycles; idiosyncratic risk; model uncertainty; robustness;

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References

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  1. Beaudry, Paul & Pages, Carmen, 2001. "The cost of business cycles and the stabilization value of unemployment insurance," European Economic Review, Elsevier, vol. 45(8), pages 1545-1572, August.
  2. Thomas J. Sargent & LarsPeter Hansen, 2001. "Robust Control and Model Uncertainty," American Economic Review, American Economic Association, vol. 91(2), pages 60-66, May.
  3. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
  4. Barillas, Francisco & Hansen, Lars Peter & Sargent, Thomas J., 2009. "Doubts or variability?," Journal of Economic Theory, Elsevier, vol. 144(6), pages 2388-2418, November.
  5. Constantinides, George M & Duffie, Darrell, 1996. "Asset Pricing with Heterogeneous Consumers," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 219-40, April.
  6. Massimiliano De Santis, 2007. "Individual Consumption Risk and the Welfare Cost of Business Cycles," American Economic Review, American Economic Association, vol. 97(4), pages 1488-1506, September.
  7. Andrew Atkeson & Christopher Phelan, 1994. "Reconsidering the Costs of Business Cycles with Incomplete Markets," NBER Chapters, in: NBER Macroeconomics Annual 1994, Volume 9, pages 187-218 National Bureau of Economic Research, Inc.
  8. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Welfare cost of business cycles in economies with individual consumption risk
    by Christian Zimmermann in NEP-DGE blog on 2012-08-26 03:29:32
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Cited by:
  1. Jang-Ok Cho & Thomas Cooley & Hyung Seok Kim, . "Business Cycle Uncertainty and Economic Welfare," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.

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