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Long-Run Consumption Risk And Asset Allocation Under Recursive Utility And Rational Inattention, Yulei Luo, Eric R. Young Jan 2015

Long-Run Consumption Risk And Asset Allocation Under Recursive Utility And Rational Inattention, Yulei Luo, Eric R. Young

Yulei Luo

We study the portfolio decision of a household with limited information-processing capacity (rational inattention or RI) in a setting with recursive utility. We find that rational inattention combined with a preference for early resolution of uncertainty could lead to a significant drop in the share of portfolios held in risky assets, even when the departure from standard expected utility with rational expectations is small. In addition, we show that the equilibrium equity premium increases with the degree of inattention because inattentive investors with recursive utility face greater long-run risk and thus require higher compensation in equilibrium. Our results are robust ...


Slow Information Diffusion And The Inertial Behavior Of Durable Consumption, Yulei Luo, Jun Nie, Eric Young Jan 2015

Slow Information Diffusion And The Inertial Behavior Of Durable Consumption, Yulei Luo, Jun Nie, Eric Young

Yulei Luo

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 income, durable consumption, and nondurable consumption at the aggregate level. Specifically, we find that SID can significantly improve the model's predictions for: (i) smoothness in durable and nondurable consumption, (ii) autocorrelation of durable consumption, and (iii) contemporaneous correlation between durable and nondurable consumption.


Model Uncertainty And Intertemporal Tax Smoothing, Yulei Luo, Jun Nie, Eric R. Young Jan 2014

Model Uncertainty And Intertemporal Tax Smoothing, Yulei Luo, Jun Nie, Eric R. Young

Yulei Luo

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 under RB. Furthermore, we show that introducing RB improves the model's predictions by generating (i) the observed relative volatility of the changes in tax rates to government spending, (ii) the observed comovement between government deficits and spending, and (iii) more consistent behavior of government budget deficits in the US economy ...


Robustness, Information-Processing Constraints, And The Current Account In Small Open Economies, Yulei Luo, Jun Nie, Eric R. Young Jan 2012

Robustness, Information-Processing Constraints, And The Current Account In Small Open Economies, Yulei Luo, Jun Nie, Eric R. Young

Yulei Luo

In this paper we examine the effects of two types of “induced uncertainty”, model uncertainty due to robustness (RB) and state uncertainty due to finite information-processing capacity (called rational inattention or RI), on consumption and the current account. We show that the combination of RB and RI improves the model’s predictions for (i) the contemporaneous correlation between the current account and income and (ii) the volatility and persistence of the current account in small open emerging and developed economies. In addition, we show that the two informational frictions improve the model’s ability to match the impulse response of ...


A Note On Entrepreneurial Risk, Capital Market Imperfections, And Heterogeneity, Yulei Luo, Liutang Gong, Heng-Fu Zou Mar 2010

A Note On Entrepreneurial Risk, Capital Market Imperfections, And Heterogeneity, Yulei Luo, Liutang Gong, Heng-Fu Zou

Yulei Luo

Empirical evidence shows that entrepreneurs 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 and capital market imperfections to explore the implications of uninsurable entrepreneurial risk for wealth distribution and aggregate activity in an incomplete market economy. It is shown that entrepreurial risk can substantially affect both the wealth distribution and the macroeconomy.


Asset Pricing Under Information-Processing Constraints, Yulei Luo, Eric R. Young Jan 2010

Asset Pricing Under Information-Processing Constraints, Yulei Luo, Eric R. Young

Yulei Luo

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 volatility and persistence of consumption growth. Second, RI increases the expected excess return. Thus, RI has the potential to play an important role in resolving extant asset pricing puzzles.


Rational Inattention, Long-Run Consumption Risk, And Portfolio Choice, Yulei Luo Jan 2010

Rational Inattention, Long-Run Consumption Risk, And Portfolio Choice, Yulei Luo

Yulei Luo

This paper explores how the introduction of rational inattention (RI) -- that agents process information subject to fi…nite channel capacity -- affects optimal consumption and investment decisions in an otherwise standard intertemporal model of portfolio choice. We …first explicitly derive optimal consumption and portfolio rules under RI and then show that introducing RI reduces the optimal share of savings invested in the risky asset because inattentive investors face greater long-run consumption risk. We also show that the investment horizon matters for portfolio allocation in the presence of RI, even if investment opportunities are constant and the utility function of investors is ...


Risk-Sensitive Consumption And Savings Under Rational Inattention, Yulei Luo, Eric R. Young Jan 2010

Risk-Sensitive Consumption And Savings Under Rational Inattention, Yulei Luo, Eric R. Young

Yulei Luo

This paper studies the consumption-savings behavior of households who have risk-sensitive preferences and suffer from limited information-processing capacity (rational inattention or RI). We first solve the model explicitly and show that RI increases precautionary savings by interacting with income uncertainty and risk-sensitivity. Given the closed-form solutions, we find that the RI model displays a wide range of observational equivalence properties, implying that consumption and savings data cannot distinguish between risk-sensitivity, robustness, or the discount factor, in any combination. We then show that the welfare costs from RI are larger for risk-sensitive households than any other observationally-equivalent settings.


The Spirit Of Capitalism, Precautionary Savings, And Consumption, Yulei Luo, William Smith, Heng-Fu Zou Jan 2009

The Spirit Of Capitalism, Precautionary Savings, And Consumption, Yulei Luo, William Smith, Heng-Fu Zou

Yulei Luo

Recent research has shown that the “spirit of capitalism”—a preference for wealth itself, in addition to consumption—has important implications for growth and asset pricing. This paper explores how the spirit of capitalism affects saving and consumption behavior. We demonstrate that the spirit of capitalism may reduce the importance of precautionary savings. It can also explain the excess sensitivity puzzle: the spirit of capitalism causes dramatic deviations from a random walk. It may also offer a partial explanation of the excess smoothness puzzle.


The Wealth Distribution And The Demand For Status, Yulei Luo, Eric R. Young Jan 2009

The Wealth Distribution And The Demand For Status, Yulei Luo, Eric R. Young

Yulei Luo

Standard economic theories of asset markets assume that assets are valued entirely for the consumption streams they can finance. This paper examines the introduction of the demand for status (as a function of wealth) into a model of uninsurable idiosyncratic risk—the “spirit of capitalism” (“soc”) assumption. We find that soc preferences lead to less inequality in wealth; placing wealth into the utility function leads to a shrinking wealth distribution. The drop in wealth concentration is smaller if the utility function implies status is a luxury good, but no parametrization leads to higher wealth Gini coefficients than the benchmark case ...