Fear of model misspecification and the robustness premium
Robust decision making implies welfare costs or robustness premia when the approximating model is the true data generating process. To examine the importance of these premia at the aggregate level we employ a simple two-sector dynamic general equilibrium model with human capital and introduce an additional form of precautionary be- havior. The latter arises from the robust decision maker's ability to reduce the effects of model misspecification through allocating time and existing human capital to this end. We find that the extent of the robustness premia critically depends on the productivity of time rela- tive to that of human capital. When the relative efficiency of time is low, despite transitory welfare costs, there are gains from following ro- bust policies in the long-run. In contrast, high relative productivity of time implies misallocation costs that remain even in the long-run. Fi- nally, depending on the technology used to reduce model uncertainty, we find that while increasing the fear of model misspecification leads to a net increase in precautionary behavior, investment and output can fall.
|Date of creation:||Sep 2010|
|Contact details of provider:|| Postal: Adam Smith Building, Glasgow G12 8RT|
Phone: 0141 330 4618
Fax: 0141 330 4940
Web page: http://www.gla.ac.uk/schools/business/research/
More information through EDIRC
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.:
- Thomas J. Sargent & Riccardo Colacito & Lars P. Hansen & Timothy Cogley, 2008. "Robustness and US Monetary," 2008 Meeting Papers 228, Society for Economic Dynamics.
- Lars Peter Hansen & Thomas J. Sargent & Thomas D. Tallarini Jr., 1997.
"Robust Permanent Income and Pricing,"
Levine's Working Paper Archive
596, David K. Levine.
- Barillas, Francisco & Hansen, Lars Peter & Sargent, Thomas J., 2009. "Doubts or variability?," Journal of Economic Theory, Elsevier, vol. 144(6), pages 2388-2418, November.
- Kai Leitemo & Ulf Söderstrom, 2005.
"Robust Monetary Policy in a Small Open Economy,"
290, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
- N. Gregory Mankiw & David Romer & David N. Weil, 1990.
"A Contribution to the Empirics of Economic Growth,"
NBER Working Papers
3541, National Bureau of Economic Research, Inc.
- Dennis, Richard, 2010. "How robustness can lower the cost of discretion," Journal of Monetary Economics, Elsevier, vol. 57(6), pages 653-667, September.
- Lars Peter Hansen & Thomas J. Sargent, 2008. "Â Time Inconsistency of Robust Control?," Chapters, in: Macroeconomics in the Small and the Large, chapter 7 Edward Elgar Publishing.
- Hayne E. Leland, 1968. "Saving and Uncertainty: The Precautionary Demand for Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 82(3), pages 465-473.
- Hans, Erwin & Wullink, Gerhard & van Houdenhoven, Mark & Kazemier, Geert, 2008. "Robust surgery loading," European Journal of Operational Research, Elsevier, vol. 185(3), pages 1038-1050, March.
- Li-Lin Ku & Chien-Pai Han, 2008. "Robust testing procedures of process locations," Quality & Quantity: International Journal of Methodology, Springer, vol. 42(5), pages 579-595, October.
- Thomas J. Sargent & LarsPeter Hansen, 2001. "Robust Control and Model Uncertainty," American Economic Review, American Economic Association, vol. 91(2), pages 60-66, May.
- David N. DeJong & Beth F. Ingram, 2001. "The Cyclical Behavior of Skill Acquisition," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(3), pages 536-561, July.
- Timothy Cogley & Riccardo Colacito & Lars Peter Hansen & Thomas J. Sargent, 2008. "Robustness and U.S. Monetary Policy Experimentation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1599-1623, December.
- Hans M. Amman & David A. Kendrick, . "Computational Economics," Online economics textbooks, SUNY-Oswego, Department of Economics, number comp1.
- Perli, Roberto & Sakellaris, Plutarchos, 1998. "Human capital formation and business cycle persistence," Journal of Monetary Economics, Elsevier, vol. 42(1), pages 67-92, June.
When requesting a correction, please mention this item's handle: RePEc:gla:glaewp:2010_24. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jeanette Findlay)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.