The choice between multiplicative and additive production uncertainty
AbstractWhen modeling output uncertainty, the multiplicative specification is consistently chosen over the additive form, despite the latter being arguably intuitively more obvious. The rationale for this seems to be that when production risk is the only source of uncertainty, additive uncertainty does not reduce output below the certainty level, while multiplicative uncertainty does. We show that, in the absence of hedging, this result is drastically modified when there is simultaneous price and output uncertainty. In this situation the theoretical implications of the two specifications are sufficiently similar to preclude any a priori choice between the two. Thus the choice between the additive and multiplicative formulations may be dictated by how each performs in empirical analyses.
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Bibliographic InfoArticle provided by Elsevier in its journal Economic Modelling.
Volume (Year): 26 (2009)
Issue (Month): 5 (September)
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Web page: http://www.elsevier.com/locate/inca/30411
Multiplicative output uncertainty Additive output uncertainty Price uncertainty;
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