Uncertainty Spillovers for Markets and Policy

Lars Hansen

Annual Review of Economics, 2021, vol. 13, issue 1, 371-396

Abstract: We live in a world filled with uncertainty. In this essay, I show that featuring this phenomenon more in economic analyses adds to our understanding of how financial markets work and how best to design prudent economic policy. This essay explores methods that allow for a broader conceptualization of uncertainty than is typical in economic investigations. These methods draw on insights from decision theory to engage in uncertainty quantification and sensitivity analysis. Uncertainty quantification in economics differs from uncertainty quantification in most sciences because there is uncertainty from the perspective both of an external observer and of people and enterprises within the model. I illustrate these methods in two example economies in which the understanding of long-term growth is limited. One example looks at uncertainty ramifications for fluctuations in financial markets, and the other considers the prudent design of policy when the quantitative magnitude of climate change and its impact on economic opportunities are unknown.

Keywords: uncertainty; valuation; financial markets; policy; climate change; ambiguity; misspecification (search for similar items in EconPapers)
JEL-codes: C18 C58 C61 D81 E44 E62 G12 (search for similar items in EconPapers)
Date: 2021
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Working Paper: Uncertainty Spillovers for Markets and Policy (2020)
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DOI: 10.1146/annurev-economics-082020-054645

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