Estimating Robustness

44 Pages Posted: 20 Apr 2017 Last revised: 14 Oct 2019

Date Written: September 24, 2019

Abstract

I estimate and evaluate a model with a representative agent who is concerned that the persistence properties of her baseline model of consumption and inflation are misspecified. Coping with model uncertainty, she discovers a pessimistically biased worst-case model that dictates her behavior. I combine interest rates and aggregate macro series with cross-equation restrictions implied by robust control theory to estimate this worst-case distribution and show that (1) the model’s predictions about key features of the yield curve are in line with the data, and (2) the degree of pessimism underlying these findings is plausible. Interpreting the worst-case as the agent’s subjective belief, I derive model implied interest rate forecasts and compare them with analogous survey expectations. I find that the model can replicate the average bias found in the survey.

Keywords: robustness, structured uncertainty, survey expectations, term-structure models, estimation, relative entropy, error probability

JEL Classification: D81, D84, C51, E10 G12

Suggested Citation

Szoke, Balint, Estimating Robustness (September 24, 2019). Available at SSRN: https://ssrn.com/abstract=2955235 or http://dx.doi.org/10.2139/ssrn.2955235

Balint Szoke (Contact Author)

NYU ( email )

19 West 4th Street
New York, NY 10003
United States

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