NBER

Andrea Vedolin

Questrom School of Business
Boston University
595 Commonwealth Avenue
Boston, MA 02215
Tel: 617/353-4168

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NBER Program Affiliations: AP
NBER Affiliation: Faculty Research Fellow
Institutional Affiliation: Boston University

NBER Working Papers and Publications

April 2020Generalized Robustness and Dynamic Pessimism
with Pascal J. Maenhout, Hao Xing: w26970
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 m...

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