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Robust Animal Spirits

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  • Matthew Smith

    (Federal Reserve Board of Governors)

  • Rhys Bidder

    (Federal Reserve Bank of San Francisco)

Abstract

In a real business cycle model, an agent's fear of model misspecification interacts with stochastic volatility to induce time varying worst case scenarios. These time varying worst case scenarios capture a notion of animal spirits where the probability distributions used to evaluate decision rules and price assets do not necessarily reflect the fundamental characteristics of the economy. Households entertain a pessimistic view of the world and their pessimism varies with the overall level of volatility in the economy, implying an amplification of the effects of volatility shocks. By using perturbation methods and Monte Carlo techniques we extend the class of models analyzed with robust control methods to include the sort of nonlinear production-based DSGE models that are popular in academic research and policymaking practice.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 265.

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Date of creation: 2013
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Handle: RePEc:red:sed013:265

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  1. Cosmin Ilut & Martin Schneider, 2012. "Ambiguous Business Cycles," Working Papers 12-06, Duke University, Department of Economics.
  2. Alejandro Justiniano & Giorgio E. Primiceri, 2008. "The Time-Varying Volatility of Macroeconomic Fluctuations," American Economic Review, American Economic Association, vol. 98(3), pages 604-41, June.
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  6. Susanto Basu & Brent Bundick, 2012. "Uncertainty shocks in a model of effective demand," Working Papers 12-15, Federal Reserve Bank of Boston.
  7. Jesus Fernández-Villaverde & Pablo Guerrón-Quintana & Juan F. Rubio-Ramírez, 2010. "Fortune or virtue: time-variant volatilities versus parameter drifting," Working Papers 10-14, Federal Reserve Bank of Philadelphia.
  8. Jesús Fernández-Villaverde & Pablo Guerrón-Quintana & Juan F. Rubio-Ramírez, 2010. "Fortune or Virtue: Time-Variant Volatilities Versus Parameter Drifting in U.S. Data," NBER Working Papers 15928, National Bureau of Economic Research, Inc.
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  11. Thomas Tallarini, . "Risk-Sensitive Real Business Cycles," GSIA Working Papers 1997-35, Carnegie Mellon University, Tepper School of Business.
  12. S. B. Aruoba & Jesús Fernández-Villaverde & Juan F. Rubio-Ramirez, 2005. "Comparing Solution Methods for Dynamic Equilibrium Economies," Levine's Bibliography 122247000000000855, UCLA Department of Economics.
  13. Glenn Rudebusch & Eric Swanson, 2008. "The bond premium in a DSGE model with long-run real and nominal risks," Working Paper Series 2008-31, Federal Reserve Bank of San Francisco.
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Cited by:
  1. Callan Windsor & Gianni La Cava & James Hansen, 2014. "Home Price Beliefs in Australia," RBA Research Discussion Papers rdp2014-04, Reserve Bank of Australia.
  2. Susanto Basu & Brent Bundick, 2012. "Uncertainty shocks in a model of effective demand," Working Papers 12-15, Federal Reserve Bank of Boston.
  3. Lars Hansen & Jaroslav Borovicka, 2013. "Robust preference expansions," 2013 Meeting Papers 1199, Society for Economic Dynamics.
  4. Xin Li & Borghan Narajabad & Ted Temzelides, 2014. "Robust Dynamic Optimal Taxation and Environmental Externalities," CESifo Working Paper Series 4562, CESifo Group Munich.

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