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Doubts and Variability: A Robust Perspective on Exotic Consumption Series

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  • Rhys M. Bidder
  • Matthew E. Smith

Abstract

In order for consumption based asset pricing models to reconcile data on returns with that on consumption, researchers have resorted to augmenting the consumption series in exotic ways. When an agent?s consumption series is subject to changes in volatility, we show that concerns for model misspecification can induce fears of both disasters and long run risk. We appeal to this pessimistic view to explain why introducing stochastic volatility in the presence of model uncertainty helps generate a more plausible unconditional market price of risk and time variation in the conditional market price of risk. Our analysis is based on a parameterization derived from Bayesian estimation of our stochastic volatility model using US consumption data.

Suggested Citation

  • Rhys M. Bidder & Matthew E. Smith, 2013. "Doubts and Variability: A Robust Perspective on Exotic Consumption Series," Working Paper Series 2013-28, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2013-28
    DOI: 10.24148/wp2013-28
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    Cited by:

    1. Demian Pouzo & Ignacio Presno, 2015. "Sovereign Default Risk and Uncertainty Premia," Papers 1512.06960, arXiv.org.
    2. Rhys Bidder & Ian Dew-Becker, 2016. "Long-Run Risk Is the Worst-Case Scenario," American Economic Review, American Economic Association, vol. 106(9), pages 2494-2527, September.
    3. Christensen, Timothy M., 2022. "Existence and uniqueness of recursive utilities without boundedness," Journal of Economic Theory, Elsevier, vol. 200(C).
    4. Andrew McKenna & Rhys Bidder, 2014. "Robust Stress Testing," 2014 Meeting Papers 853, Society for Economic Dynamics.
    5. Jaroslav Borovička & Lars Peter Hansen & José A. Scheinkman, 2016. "Misspecified Recovery," Journal of Finance, American Finance Association, vol. 71(6), pages 2493-2544, December.
    6. Emi Nakamura & Dmitriy Sergeyev & Jón Steinsson, 2017. "Growth-Rate and Uncertainty Shocks in Consumption: Cross-Country Evidence," American Economic Journal: Macroeconomics, American Economic Association, vol. 9(1), pages 1-39, January.
    7. Meyer-Gohde, Alexander, 2019. "Generalized entropy and model uncertainty," Journal of Economic Theory, Elsevier, vol. 183(C), pages 312-343.
    8. Demian Pouzo & Ignacio Presno, 2016. "Sovereign Default Risk and Uncertainty Premia," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(3), pages 230-266, July.
    9. Timothy M. Christensen, 2020. "Existence and uniqueness of recursive utilities without boundedness," Papers 2008.00963, arXiv.org, revised Aug 2021.
    10. Rhys M. Bidder & Ian Dew-Becker, 2014. "Long-Run Risk is the Worst-Case Scenario: Ambiguity Aversion and Non-Parametric Estimation of the Endowment Process," Working Paper Series 2014-16, Federal Reserve Bank of San Francisco.
    11. Bäuerle, Nicole & Jaśkiewicz, Anna, 2018. "Stochastic optimal growth model with risk sensitive preferences," Journal of Economic Theory, Elsevier, vol. 173(C), pages 181-200.

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    More about this item

    Keywords

    Consumption (Economics);

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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