This paper studies the implications of limited information-processing capacity (also called rational inattention) for asset pricing in a linear-quadratic permanent income model. We have two main results. First, RI increases the size of the risk adjustment to asset prices by increasing the...

Empirical evidence shows that entrepeneurs hold a large fraction of wealth, have higher saving rates than workers, and face substantial uninsurable entrepreneurial and investment risks. This paper constructs a heterogeneous-agent general equilibrium model with uninsurable entrepreneurial risk...

This paper derives the general equilibrium effects of rational inattention (or RI; Sims 2003, 2010) in a model of incomplete income insurance (Huggett 1993, Wang 2003). We show that, under the assumption of CARA utility with Gaussian shocks, the Permanent Income Hypothesis (PIH) arises in...

In this paper we examine how model uncertainty due to the preference for robustness (RB) affects optimal taxation and the evolution of debt in the Barro tax-smoothing model (1979). We first study how the government spending shocks are absorbed in the short run by varying taxes or through debt...

This paper studies the aggregate dynamics of durable and nondurable consumption under slow information diffusion (SID) due to noisy observations and learning within the permanent income framework. We show that SID can significantly improve the model’s predictions on the joint behavior of...

This paper provides a tractable continuous-time constant-absolute-risk averse (CARA)-Gaussian framework to quantitatively explore how the preference for robustness (RB) affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general...

A leading theory of consumption behavior is that consumers choose their consumption based only on their expected total lifetime income. This theory is called the permanent income hypothesis. According to this theory, consumers should adjust their consumption if they experience a change that...

In this paper we examine the effects of model misspecification (robustness or RB) on international consumption correlations in two otherwise standard small open economy models: one with perfect state observation and the other with imperfect state observation. We show that in the presence of...

In this paper we examine the effects of model misspecification (robustness or RB) on international consumption correlations in an otherwise standard small open economy model with endogenous capital accumulation. We show that in the presence of capital mobility in financial markets, RB lowers the...

In this paper we examine how model uncertainty due to the preference for robustness (RB) affects optimal taxation and debt structure in the Barro tax-smoothing model (1979). We first study how the government spending shocks are absorbed in the short run by varying taxes or through debt under RB....