Robustness, Low Risk-Free Rates, and Consumption Volatility in General Equilibrium

Yulei Luo (), Jun Nie and Eric Young

MPRA Paper from University Library of Munich, Germany

Abstract: This paper develops a tractable continuous-time recursive utility (RU) version of the Huggett (1993) model to explore how the preference for robustness (RB) interacts with intertemporal substitution and risk aversion and then affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB reduces the equilibrium interest rate and the relative volatility of consumption growth to income growth when the income process is stationary, but our benchmark model cannot match the observed relative volatility. An extension to an RU-RB model with a risky asset is successful at matching this ratio. The model implies that the welfare costs of uncertainty are very large.

Keywords: Robustness; Precautionary Savings; the Permanent Income Hypothesis; Low Interest Rates; Consumption and Income Inequality; General Equilibrium (search for similar items in EconPapers)
JEL-codes: E2 E21 (search for similar items in EconPapers)
Date: 2017-07-05
New Economics Papers: this item is included in nep-dge, nep-mac, nep-ore and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:80046

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