Robust Control, Informational Frictions, and International Consumption Correlations

HKIMR Working Paper No.21/2013

40 Pages Posted: 27 Nov 2013

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: November 27, 2013

Abstract

In this paper we examine the effects of model misspecification (robustness or RB) on international consumption correlations in two otherwise standard small open economy models: one with perfect state observation and the other with imperfect state observation. 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 with perfect state observation cannot explain the observed consumption correlations quantitatively. We then show that the RB model with imperfect state observation is capable of matching the behavior of international consumption quantitatively via two channels: (i) the gradual response to income shocks that increases the correlations and (ii) the presence of the common noise shocks that reduce the correlations.

Keywords: Robustness, Imperfect State Observation, International Consumption Correlations

JEL Classification: D83, E21, F41, G15

Suggested Citation

Luo, Yulei and Nie, Jun and Young, Eric R., Robust Control, Informational Frictions, and International Consumption Correlations (November 27, 2013). HKIMR Working Paper No.21/2013. Available at SSRN: https://ssrn.com/abstract=2360434 or http://dx.doi.org/10.2139/ssrn.2360434

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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