Ignorance, Pervasive Uncertainty, and Household Finance

43 Pages Posted: 7 Sep 2017 Last revised: 30 Sep 2019

See all articles by Yulei Luo

Yulei Luo

University of Hong Kong

Jun Nie

Federal Reserve Bank of Kansas City

Haijun Wang

Shanghai University of Finance and Economics

Date Written: September 4, 2017

Abstract

This paper studies how the interaction between two types of uncertainty due to ignorance affects strategic consumption-portfolio rules, precautionary savings, and welfare in general equilibrium. We incorporate these two types of uncertainties into a recursive utility version of a canonical Merton (1971) model with uninsurable labor income and unknown income growth and derive analytical solutions and testable implications. We show that the interaction between the two types of uncertainty plays a key role in determining the demand for precautionary savings and risky assets. We derive formulas to evaluate both marginal and total welfare costs of ignorance-induced uncertainty and show they are significant for plausible parameter values.

Keywords: Ignorance, Unknown Income Growth, Induced Uncertainty, Strategic Asset Allocation

JEL Classification: C61, D81, E21

Suggested Citation

Luo, Yulei and Nie, Jun and Wang, Haijun, Ignorance, Pervasive Uncertainty, and Household Finance (September 4, 2017). Available at SSRN: https://ssrn.com/abstract=3031969 or http://dx.doi.org/10.2139/ssrn.3031969

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

Haijun Wang

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

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