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Robustness, Low Risk-Free Rates, and Consumption Volatility in General Equilibrium

Author

Listed:
  • Luo, Yulei
  • Nie, Jun
  • Young, Eric

Abstract

This paper develops a tractable continuous-time recursive utility (RU) version of the Huggett (1993) model to explore how the preference for robustness (RB) interacts with intertemporal substitution and risk aversion and then affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB reduces the equilibrium interest rate and the relative volatility of consumption growth to income growth when the income process is stationary, but our benchmark model cannot match the observed relative volatility. An extension to an RU-RB model with a risky asset is successful at matching this ratio. The model implies that the welfare costs of uncertainty are very large.

Suggested Citation

  • Luo, Yulei & Nie, Jun & Young, Eric, 2017. "Robustness, Low Risk-Free Rates, and Consumption Volatility in General Equilibrium," MPRA Paper 80046, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:80046
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    File URL: https://mpra.ub.uni-muenchen.de/80046/1/MPRA_paper_80046.pdf
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    References listed on IDEAS

    as
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Robustness, Low Risk-Free Rates, and Consumption Volatility in General Equilibrium
      by Christian Zimmermann in NEP-DGE blog on 2017-07-12 19:07:55

    More about this item

    Keywords

    Robustness; Precautionary Savings; the Permanent Income Hypothesis; Low Interest Rates; Consumption and Income Inequality; General Equilibrium;

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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