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Robust Animal Spirits

  • Matthew Smith

    (Federal Reserve Board of Governors)

  • Rhys Bidder

    (Federal Reserve Bank of San Francisco)

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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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
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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  15. 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.
  16. Koop, Gary & Pesaran, M. Hashem & Potter, Simon M., 1996. "Impulse response analysis in nonlinear multivariate models," Journal of Econometrics, Elsevier, vol. 74(1), pages 119-147, September.
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