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

Roman Frydman (), Soren Johansen, Anders Rahbek and Morten Tabor
Additional contact information
Roman Frydman: New York University
Morten Tabor: University of Copenhagen

No 92, Working Papers Series from Institute for New Economic Thinking

Abstract: This paper introduces 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 John 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) yet 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: 62 pages
Date: 2019-02
New Economics Papers: this item is included in nep-mac and nep-upt
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:thk:wpaper:92

DOI: 10.2139/ssrn.3346766

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