Robust Control, Informational Frictions, and International Consumption Correlations

41 Pages Posted: 19 Jul 2010

See all articles by Yulei Luo

Yulei Luo

University of Hong Kong

Jun Nie

Federal Reserve Bank of Kansas City

Eric R. Young

University of Virginia

Multiple version iconThere are 2 versions of this paper

Date Written: March 9, 2010

Abstract

In this paper we examine the effects of two types of information imperfections, robustness (RB) and finite information-processing capacity (called rational inattention or RI), on international consumption correlations in an otherwise standard small open economy model. We show that in the presence of capital mobility in financial markets, RB lowers the international consumption correlations by generating heterogeneous responses of consumption to income shocks across countries facing different macroeconomic uncertainty. However, the calibrated RB model cannot explain the observed consumption correlations quantitatively. We then show that introducing RI is capable of matching the behavior of international consumption quantitatively via two channels: (1) the gradual response to income shocks that increases the correlations and (2) the presence of the common noise shocks that reduce the correlations.

Suggested Citation

Luo, Yulei and Nie, Jun and Young, Eric R., Robust Control, Informational Frictions, and International Consumption Correlations (March 9, 2010). Available at SSRN: https://ssrn.com/abstract=1645055 or http://dx.doi.org/10.2139/ssrn.1645055

Yulei Luo (Contact Author)

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, HK
China

Jun Nie

Federal Reserve Bank of Kansas City ( email )

1 Memorial Drive
Kansas City, MO 64198
United States
(816) 881-2255 (Phone)
(816) 881-2199 (Fax)

HOME PAGE: http://homepages.nyu.edu/~jn461/research.htm

Eric R. Young

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

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