The Knightian Uncertainty Hypothesis: Unforeseeable Change and Muth�s Consistency Constraint in Modeling Aggregate Outcomes

Roman Frydman, Soren Johansen, Anders Rahbek and Morten Tabor ()
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Roman Frydman: Department of Economics, New York University

No 19-02, Discussion Papers from University of Copenhagen. Department of Economics

Abstract: This paper proposes the Knightian Uncertainty Hypothesis (KUH), a new approach to macroeconomics and finance theory. KUH rests on a novel mathematical framework that characterizes both measurable and Knightian uncertainty about economic outcomes. Relying on this framework and Muth�s pathbreaking hypothesis, KUH represents participants� forecasts to be consistent with both uncertainties. KUH thus enables models of aggregate outcomes that 1) are premised on market participants� rationality, and 2) accord a role to both fundamental and psychological (and other non-fundamental) factors in driving outcomes. The paper also suggests how a KUH model�s quantitative predictions can be confronted with time-series data.

Keywords: Unforeseeable Change; Knightian Uncertainty; Muth�s Hypothesis; Model Ambiguity; REH; Behavioral Finance (search for similar items in EconPapers)
JEL-codes: C02 C51 D84 E00 G41 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2019-02-21
New Economics Papers: this item is included in nep-hpe, nep-mac and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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