Robust Permanent Income in General Equilibrium

44 Pages Posted: 22 Nov 2015

See all articles by Jun Nie

Jun Nie

Federal Reserve Bank of Kansas City

Yulei Luo

University of Hong Kong

Eric R. Young

University of Virginia

Date Written: October 29, 2015

Abstract

his paper provides a tractable continuous-time constant-absolute-risk averse (CARA)-Gaussian framework to quantitatively explore how the preference for robustness (RB) affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB significantly reduces the equilibrium interest rate, and reduces the relative volatility of consumption growth to income growth when the income process is stationary. Furthermore, we find that the welfare costs of model uncertainty are non-trivial for plausibly estimated income processes and calibrated RB parameter values. Finally, we extend the benchmark model to consider the separation of risk aversion and intertemporal substitution.

Keywords: Robustness, Precautionary Savings, the Permanent Income Hypothesis, Low Interest Rates, Consumption and Income Inequality, General Equilibrium

JEL Classification: C61, D81, E21

Suggested Citation

Nie, Jun and Luo, Yulei and Young, Eric R., Robust Permanent Income in General Equilibrium (October 29, 2015). Federal Reserve Bank of Kansas City Working Paper No. 15-14. Available at SSRN: https://ssrn.com/abstract=2693753 or http://dx.doi.org/10.2139/ssrn.2693753

Jun Nie (Contact Author)

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

Yulei Luo

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, HK
China

Eric R. Young

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

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