•This paper studies the dynamics of wealth inequality in a Blanchard–Yaari model.•It assumes idiosyncratic investment returns are subject to Knightian uncertainty.•We find that Knightian uncertainty ...helps to resolve the convergence rate puzzle identified by Gabaix et al. (2016).
The dynamics of wealth inequality are studied in a continuous-time Blanchard/Yaari model. Investment returns are idiosyncratic and subject to Knightian uncertainty. In response, agents formulate robust portfolio policies. These policies are nonhomothetic; wealthy agents invest a higher fraction of their wealth in uncertain assets yielding higher mean returns. This produces a feedback mechanism that amplifies inequality. It also produces an accelerated rate of convergence, which helps resolve a puzzle recently identified by Gabaix et al. (2016). An empirically plausible increase in uncertainty can account for about half of the recent increase in top wealth shares.
Gresham's Law of Model Averaging Cho, In-Koo; Kasa, Kenneth
The American economic review,
11/2017, Letnik:
107, Številka:
11
Journal Article
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A decision maker doubts the stationarity of his environment. In response, he uses two models, one with time-varying parameters, and another with constant parameters. Forecasts are then based on a ...Bayesian model averaging strategy, which mixes forecasts from the two models. In reality, structural parameters are constant, but the {unknown) true model features expectational feedback, which the reduced-form models neglect. This feedback permits fears of parameter instability to become self-confirming. Within the context of a standard asset-pricing model, we use the tools of large deviations theory to show that even though the constant parameter model would converge to the rational expectations equilibrium if considered in isolation, the mere presence of an unstable alternative drives it out of consideration.
“WAIT AND SEE” OR “FEAR OF FLOATING”? Lei, Xiaowen; Lu, Dong; Kasa, Kenneth
Macroeconomic dynamics,
06/2022, Letnik:
26, Številka:
4
Journal Article
Recenzirano
This paper studies the evolution of China’s exchange rate policy using real options theory. With intervention costs and ongoing uncertainty, intervention involves the exercise of an option. Increased ...uncertainty increases the value of this option. This “wait and see” effect leads the Central Bank to widen its intervention band. However, increased volatility also produces larger fluctuations in welfare, which creates a “fear of floating.” This induces the Central Bank to set a tighter band. To study this trade-off, our paper incorporates stochastic volatility into a new Keynesian target zone model and then calibrates it to data from China. We find that increased uncertainty leads to a tighter intervention band, both in the data and in the model. Hence, in China, “fear of floating” appears to dominate the “wait and see” effect.
Robustness and exchange rate volatility Djeutem, Edouard; Kasa, Kenneth
Journal of international economics,
09/2013, Letnik:
91, Številka:
1
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This paper studies exchange rate volatility within the context of the monetary model of exchange rates. We assume that agents regard this model as merely a benchmark, or reference model, and attempt ...to construct forecasts that are robust to model misspecification. We show that revisions of robust forecasts are more volatile than revisions of nonrobust forecasts, and that empirically plausible concerns for model misspecification can explain observed exchange rate volatility. We also briefly discuss the implications of robust forecasts for a number of other exchange rate puzzles.
•We study exchange rate volatility within the context of the monetary model.•We assume agents regard this model as merely a benchmark, and construct forecasts that are robust to model misspecification.•We show that robust forecast can explain observed exchange rate volatility.
Learning and Model Validation CHO, IN-KOO; KASA, KENNETH
The Review of economic studies,
01/2015, Letnik:
82, Številka:
1 (290)
Journal Article
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This paper studies adaptive learning with multiple models. An agent operating in a self-referential environment is aware of potential model misspecification, and tries to detect it, in real-time, ...using an econometric specification test. If the current model passes the test, it is used to construct an optimal policy. If it fails the test, a new model is selected. As the rate of coefficient updating decreases, one model becomes dominant, and is used "almost always". Dominant models can be characterized using the tools of large deviations theory. The analysis is used to address two questions posed by Sargent's Phillips Curve model.
This article develops a dynamic asset pricing model with persistent heterogeneous beliefs. The model features competitive traders who receive idiosyncratic signals about an underlying fundamentals ...process. We adapt Futia's (1981) frequency domain methods to derive conditions on the fundamentals that guarantee non-invertibility of the mapping between observed market data and the underlying shocks to agents' information sets. When these conditions are satisfied, agents remain asymmetrically informed in equilibrium and must 'forecast the forecasts of others'. An econometrician, who incorrectly imposes a homogeneous beliefs equilibrium, will find that the asset price displays violations of variance bounds, predictability of excess returns, and rejections of cross-equation restrictions.
This paper studies the problem of an agent who wants to prevent the state from exceeding a critical threshold. Even though the agent is presumed to know the model, the optimal policy is computed by ...solving a conventional robust control problem. That is, robustness is induced here by objectives rather than uncertainty, and so is an example of the duality between risk-sensitivity and robustness. However, here the agent only incurs costs upon escape to a critical region, not during ‘normal times’. We argue that this is often a more realistic model of macroeconomic policymaking.
This article studies a version of Obstfeld's (Journal of International Economics 43 (1997), 61-77) "escape clause" model. The model is calibrated to produce three rational expectations equilibria. ...Two of these equilibria are E-stable and one is unstable. Dynamics are introduced by assuming that agents must learn about the government's decision rule. It is assumed they do this using a stochastic approximation algorithm. It turns out that as a certain parameter describing the sensitivity of beliefs to new information gets small, the algorithm converges to a small noise diffusion process. The dynamics of exchange rate changes are then characterized using large deviation techniques from Freidlin and Wentzell (Random Perturbations of Dynamical Systems, Second Edition, Berlin: Springer-Verlag, 1998). These methods describe the sense in which the limiting distribution of exchange rate changes is approximated by a two-state Markov-Switching process, where the two states correspond to the two E-stable equilibria. The model is calibrated to the exchange rate histories of Argentina, Brazil, and Mexico. Currency crises in these countries resemble the predicted "escape routes" of the model. A key feature of these escape routes is that expectations of a devaluation erupt suddenly, without large contemporaneous shocks. This is consistent with evidence showing that crises are often poorly anticipated by financial markets.
This paper considers a standard Kalman filtering problem subject to model uncertainty and information-processing constraints. It draws a connection between robust filtering Hansen and Sargent, 2004. ...Robust control and economic model uncertainty. Monograph. In press and Rational Inattention Sims, 2003. Implications of rational inattention, Journal of Monetary Economics 50 (3), 665–690. Considered separately, robustness and Rational Inattention are shown to be observationally equivalent, in the sense that a higher filter gain can either be interpreted as an increased preference for robustness, or an increased ability to process information. However, it is more interesting to consider them jointly. In this case, it is argued that an increased preference for robustness can be interpreted as an increased demand for information processing, while Sims' model of Rational Inattention can be interpreted as placing a constraint on the available supply. This suggests that the way agents actually implement robust decision rules is by allocating some of their scarce information processing capacity to problems that are characterized by high degrees of model uncertainty and risk-sensitivity.
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