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Rational Ignorance In Long-Run Risk Models

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Author Info

  • Stefano D'Addona

    (University of Roma Tre)

  • Frode Brevik

    (Free University Amsterdam)

Abstract

We document an unpleasant feature of Epstein-Zin preferences in a stylized model economy of the long-run risk type now widespread in Asset Pricing: Agents with preference parameters commonly described as indicating a "preference for early resolution of uncertainty" achieve higher utility levels if they can commit to ignoring information on the state of the business cycle. For parameter choices similar to those used to explain asset prices, an agent can achieve utility gains equivalent to a more than 40 % increase in life-time consumption by committing to ignore information on the trend growth rate of the endowment good. We show that opting for such a coarser information set can be implemented and supported as an equilibrium strategy.

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File URL: http://host.uniroma3.it/centri/crei/pubblicazioni/workingpapers2011/CREI_08_2011.pdf
File Function: First version, 2011
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Bibliographic Info

Paper provided by CREI Università degli Studi Roma Tre in its series Working Papers with number 0811.

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Length: 20 pages
Date of creation: 2011
Date of revision: 2011
Handle: RePEc:rcr:wpaper:08_11

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Related research

Keywords: Recursive preferences; Epstein-Zin preferences; Uncertainty aversion; Information processing; Time inconsistency;

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  1. Thomas Tallarini, . "Risk-Sensitive Real Business Cycles," GSIA Working Papers 1997-35, Carnegie Mellon University, Tepper School of Business.
  2. Riccardo Colacito & Mariano Croce, 2005. "Risks For The Long Run And The Real Exchange Rate," 2005 Meeting Papers 794, Society for Economic Dynamics.
  3. Taeyoung Doh, 2013. "Long‐Run Risks In The Term Structure Of Interest Rates: Estimation," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 28(3), pages 478-497, 04.
  4. Jesper Rangvid & Maik Schmeling & Andreas Schrimpf, 2009. "Global Asset Pricing: Is There a Role for Long-run Consumption Risk?," CREATES Research Papers 2009-57, School of Economics and Management, University of Aarhus.
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