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On the relation between robust and Bayesian decision making

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  • Adam, Klaus

Abstract

This paper compares Bayesian decision theory with robust decision theory where the decision maker optimizes with respect to the worst state realization. For a class of robust decision problems there exists a sequence of Bayesian decision problems whose solution converges towards the robust solution. It is shown that the limiting Bayesian problem displays infinite risk aversion and that decisions are insensitive (robust) to the precise assignment of prior probabilities. This holds independent from whether the preference for robustness is global or restricted to local perturbations around some reference model. --

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 28 (2004)
Issue (Month): 10 (September)
Pages: 2105-2117

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Handle: RePEc:eee:dyncon:v:28:y:2004:i:10:p:2105-2117

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References

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  1. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, January.
  2. Alexei Onatski & James H. Stock, 1999. "Robust monetary policy under model uncertainty in a small model of the U.S. economy," Proceedings, Federal Reserve Bank of San Francisco.
  3. Hansen, Lars Peter & Sargent, Thomas J & Tallarini, Thomas D, Jr, 1999. "Robust Permanent Income and Pricing," Review of Economic Studies, Wiley Blackwell, vol. 66(4), pages 873-907, October.
  4. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  5. Gary Chamberlain, 2000. "Econometric applications of maxmin expected utility," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(6), pages 625-644.
  6. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  7. Duffie, Darrell & Epstein, Larry G, 1992. "Asset Pricing with Stochastic Differential Utility," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 411-36.
  8. Peter von zur Muehlen, 2001. "Activist vs. non-activist monetary policy: optimal rules under extreme uncertainty," Finance and Economics Discussion Series 2001-02, Board of Governors of the Federal Reserve System (U.S.).
  9. Duffie, Darrel & Lions, Pierre-Louis, 1992. "PDE solutions of stochastic differential utility," Journal of Mathematical Economics, Elsevier, vol. 21(6), pages 577-606.
  10. Alexei Onatski, 2000. "Minimax Analysis of Monetary Policy Under Model Uncertainty," Econometric Society World Congress 2000 Contributed Papers 1818, Econometric Society.
  11. J. Tetlow, Robert & von zur Muehlen, Peter, 2001. "Robust monetary policy with misspecified models: Does model uncertainty always call for attenuated policy?," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 911-949, June.
  12. van der Ploeg, Frederick, 1993. "A Closed-Form Solution for a Model of Precautionary Saving," Review of Economic Studies, Wiley Blackwell, vol. 60(2), pages 385-95, April.
  13. Duffie, Darrell & Epstein, Larry G, 1992. "Stochastic Differential Utility," Econometrica, Econometric Society, vol. 60(2), pages 353-94, March.
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Cited by:
  1. Robert Tetlow & Peter von zur Muehlen, 2004. "Avoiding Nash Inflation: Bayesian and Robus Responses to Model Uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(4), pages 869-899, October.
  2. Küster, Keith & Wieland, Volker, 2005. "Insurance Policies for Monetary Policy in the Euro Area," CEPR Discussion Papers 4956, C.E.P.R. Discussion Papers.
  3. Bigio, Saki, 2009. "Learning under Fear of Floating," Working Papers 2009-004, Banco Central de Reserva del Perú.
  4. Rama Cont, 2006. "Model uncertainty and its impact on the pricing of derivative instruments," Post-Print halshs-00002695, HAL.
  5. Q. Farooq Akram & Yakov Ben-Haim & Øyvind Eitrheim, 2006. "Managing uncertainty through robust-satisficing monetary policy," Working Paper 2006/10, Norges Bank.
  6. Pauline Barrieu & Bernard Sinclair Desgagne, 2009. "Economic policy when models disagree," LSE Research Online Documents on Economics 37607, London School of Economics and Political Science, LSE Library.
  7. Renaud, J. & Thibault, J. & Lanouette, R. & Kiss, L.N. & Zaras, K. & Fonteix, C., 2007. "Comparison of two multicriteria decision aid methods: Net Flow and Rough Set Methods in a high yield pulping process," European Journal of Operational Research, Elsevier, vol. 177(3), pages 1418-1432, March.

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