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Article: Induced uncertainty, market price of risk, and the dynamics of consumption and wealth

TitleInduced uncertainty, market price of risk, and the dynamics of consumption and wealth
Authors
Issue Date2016
PublisherElsevier. The Journal's web site is located at http://www.elsevier.com/locate/jet
Citation
Journal of Economic Theory, 2016, v. 163, p. 1-41 How to Cite?
AbstractIn this paper we examine the implications of model uncertainty or robustness (RB) for consumption and saving and the market price of uncertainty under limited information-processing capacity (rational inattention or RI). First, we show that RI by itself creates an additional demand for robustness that leads to higher “induced uncertainty” facing consumers. Second, if we allow capacity to be elastic, RB increases the optimal level of attention. Third, we explore how the induced uncertainty composed of (i) model uncertainty due to RB and (ii) state uncertainty due to RI, affects consumption and wealth dynamics, the market price of uncertainty, and the welfare losses due to incomplete information. We find that induced uncertainty can better explain the observed consumption-income volatility and market price of uncertainty – low attention increases the effect of model misspecification.
Persistent Identifierhttp://hdl.handle.net/10722/223381

 

DC FieldValueLanguage
dc.contributor.authorLuo, Y-
dc.contributor.authorYoung, E-
dc.date.accessioned2016-02-23T01:57:37Z-
dc.date.available2016-02-23T01:57:37Z-
dc.date.issued2016-
dc.identifier.citationJournal of Economic Theory, 2016, v. 163, p. 1-41-
dc.identifier.urihttp://hdl.handle.net/10722/223381-
dc.description.abstractIn this paper we examine the implications of model uncertainty or robustness (RB) for consumption and saving and the market price of uncertainty under limited information-processing capacity (rational inattention or RI). First, we show that RI by itself creates an additional demand for robustness that leads to higher “induced uncertainty” facing consumers. Second, if we allow capacity to be elastic, RB increases the optimal level of attention. Third, we explore how the induced uncertainty composed of (i) model uncertainty due to RB and (ii) state uncertainty due to RI, affects consumption and wealth dynamics, the market price of uncertainty, and the welfare losses due to incomplete information. We find that induced uncertainty can better explain the observed consumption-income volatility and market price of uncertainty – low attention increases the effect of model misspecification.-
dc.languageeng-
dc.publisherElsevier. The Journal's web site is located at http://www.elsevier.com/locate/jet-
dc.relation.ispartofJournal of Economic Theory-
dc.rights© <year>. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/-
dc.titleInduced uncertainty, market price of risk, and the dynamics of consumption and wealth-
dc.typeArticle-
dc.identifier.emailLuo, Y: yluo@econ.hku.hk-
dc.identifier.authorityLuo, Y=rp01083-
dc.identifier.doi10.1016/j.jet.2016.01.003-
dc.identifier.hkuros257104-
dc.identifier.volume163-
dc.identifier.spage1-
dc.identifier.epage41-

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