Stochastic optimization and worst-case analysis in monetary policy design

  • In this paper, we examine the cost of insurance against model uncertainty for the Euro area considering four alternative reference models, all of which are used for policy-analysis at the ECB.We find that maximal insurance across this model range in terms of aMinimax policy comes at moderate costs in terms of lower expected performance. We extract priors that would rationalize the Minimax policy from a Bayesian perspective. These priors indicate that full insurance is strongly oriented towards the model with highest baseline losses. Furthermore, this policy is not as tolerant towards small perturbations of policy parameters as the Bayesian policy rule. We propose to strike a compromise and use preferences for policy design that allow for intermediate degrees of ambiguity-aversion.These preferences allow the specification of priors but also give extra weight to the worst uncertain outcomes in a given context. JEL Klassifikation: E52, E58, E61

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Author:Berc Rustem, Volker WielandORCiDGND, Stan Zakovic
Parent Title (German):Center for Financial Studies (Frankfurt am Main): CFS working paper series ; No. 2005,14
Series (Serial Number):CFS working paper series (2005, 14)
Document Type:Working Paper
Year of Completion:2005
Year of first Publication:2005
Publishing Institution:Universitätsbibliothek Johann Christian Senckenberg
Release Date:2005/06/13
Tag:Euro Area; Minimax; Model Uncertainty; Monetary Policy Rules; Robustness
GND Keyword:Europäische Union; Währungsunion; Mitgliedsstaaten; Europäische Zentralbank; Geldpolitik
Issue:April 2005
Institutes:Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Licence (German):License LogoDeutsches Urheberrecht