Generalized Robustness and Dynamic Pessimism / Pascal J. Maenhout, Andrea Vedolin, Hao Xing.

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Maenhout, Pascal J

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w26970.Publication details: Cambridge, Mass. National Bureau of Economic Research 2020.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: 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.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w26970 (Browse shelf(Opens below))	Not For Loan

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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.