Sets of Models and Prices of Uncertainty

Lars Hansen and Thomas Sargent

No 22000, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: A decision maker constructs a convex set of nonnegative martingales to use as likelihood ratios that represent parametric alternatives to a baseline model and also non-parametric models statistically close to both the baseline model and the parametric alternatives. Max-min expected utility over that set gives rise to equilibrium prices of model uncertainty expressed as worst-case distortions to drifts in a representative investor's baseline model. We offer quantitative illustrations for baseline models of consumption dynamics that display long-run risk. We describe a set of parametric alternatives that generates countercyclical prices of uncertainty.

JEL-codes: C01 C02 C14 C52 E3 (search for similar items in EconPapers)
Date: 2016-02
New Economics Papers: this item is included in nep-mac and nep-upt
Note: AP
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Citations: View citations in EconPapers (4)

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