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Structured ambiguity and model misspecification

Lars Hansen and Thomas J. Sargent

Journal of Economic Theory, 2022, vol. 199, issue C

Abstract: A decision maker is averse to not knowing a prior over a set of restricted structured models (ambiguity) and suspects that each structured model is misspecified. The decision maker evaluates intertemporal plans under all of the structured models and, to recognize possible misspecifications, under unstructured alternatives that are statistically close to them. Likelihood ratio processes are used to represent unstructured alternative models, while relative entropy restricts a set of unstructured models. A set of structured models might be finite or indexed by a finite-dimensional vector of unknown parameters that could vary in unknown ways over time. We model such a decision maker with a dynamic version of variational preferences and revisit topics including dynamic consistency and admissibility.

Keywords: Ambiguity; Misspecification; Relative entropy; Robustness; Variational preferences; Structured and unstructured models (search for similar items in EconPapers)
JEL-codes: C18 C54 D81 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:199:y:2022:i:c:s0022053120301587

DOI: 10.1016/j.jet.2020.105165

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