We examine the potential importance of consumer ambiguity aversion for asset prices and how consumption ‡fluctuations influence consumer welfare. First, considering a simple Mehra-Prescott-style endowment economy with a representative agent facing consumption fluctuations calibrated to match U.S. data, we study to what extent ambiguity aversion can deliver asset prices that are consistent with data: a high return on equity and a low return on riskfree bonds. For some configurations of preference parameters— a discount factor, a degree of relative risk aversion, and a measure of ambiguity aversion— we find that it can. Then, we use these parameter configurations to investigate how much consumers would be willing to pay to reduce endowment fluctuations to zero, thus delivering a Lucas-style welfare cost of fluctuations. These costs turn out to be very large: consumers are willing to pay over 10% of consumption in permanent terms.
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Paper provided by Stockholm University, Institute for International Economic Studies in its series Seminar Papers with number
752.
Length: 36 pages Date of creation: 06 Aug 2007 Date of revision: Handle: RePEc:hhs:iiessp:0752
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Larry G. Epstein & Martin Schneider, 2001.
"Recursive Multiple-Priors,"
RCER Working Papers
485, University of Rochester - Center for Economic Research (RCER).
[Downloadable!]
Other versions:
Robert E. Lucas Jr. & Nancy L. Stokey, 1982.
"Optimal Growth with Many Consumers,"
Discussion Papers
518, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
[Downloadable!]