Generalized Robustness and Dynamic Pessimism /
Maenhout, Pascal J.
Generalized Robustness and Dynamic Pessimism / Pascal J. Maenhout, Andrea Vedolin, Hao Xing. - Cambridge, Mass. National Bureau of Economic Research 2020. - 1 online resource: illustrations (black and white); - NBER working paper series no. w26970 . - Working Paper Series (National Bureau of Economic Research) no. w26970. .
April 2020.
This paper develops a theory of dynamic pessimism and its impact on asset prices. Notions of time-varying pessimism arise endogenously in our setting as a consequence of agents' concern for model misspecification. We generalize the robust control approach of Hansen and Sargent (2001) by replacing relative entropy as a measure of discrepancy between models by the more general family of Cressie-Read discrepancies. As a consequence, the decision-maker's distorted beliefs appear as an endogenous state variable driving risk aversion, portfolio decisions, and equilibrium asset prices. Using survey data, we estimate time-varying pessimism and find that such a proxy features a strong business cycle component. We then show that using our measure of pessimism helps match salient features in equity markets such as excess volatility and high equity premium.
System requirements: Adobe [Acrobat] Reader required for PDF files.
Mode of access: World Wide Web.
Generalized Robustness and Dynamic Pessimism / Pascal J. Maenhout, Andrea Vedolin, Hao Xing. - Cambridge, Mass. National Bureau of Economic Research 2020. - 1 online resource: illustrations (black and white); - NBER working paper series no. w26970 . - Working Paper Series (National Bureau of Economic Research) no. w26970. .
April 2020.
This paper develops a theory of dynamic pessimism and its impact on asset prices. Notions of time-varying pessimism arise endogenously in our setting as a consequence of agents' concern for model misspecification. We generalize the robust control approach of Hansen and Sargent (2001) by replacing relative entropy as a measure of discrepancy between models by the more general family of Cressie-Read discrepancies. As a consequence, the decision-maker's distorted beliefs appear as an endogenous state variable driving risk aversion, portfolio decisions, and equilibrium asset prices. Using survey data, we estimate time-varying pessimism and find that such a proxy features a strong business cycle component. We then show that using our measure of pessimism helps match salient features in equity markets such as excess volatility and high equity premium.
System requirements: Adobe [Acrobat] Reader required for PDF files.
Mode of access: World Wide Web.