A Bayesian Model of Knightian Uncertainty
AbstractA long tradition suggests a fundamental distinction between situations of risk, where true objective probabilities are known, and unmeasurable uncertainties where no such probabilities are given. This distinction can be captured in a Bayesian model where uncertainty is represented by the agent's subjective belief over the parameter governing future income streams. Whether uncertainty reduces to ordinary risk depends on the agent's ability to smooth consumption. Uncertainty can have a major behavioral and economic impact, including precautionary behavior that may appear overly conservative to an outside observer. We argue that one of the main characteristics of uncertain beliefs is that they are not empirical, in the sense that they cannot be objectively tested to determine whether they are right or wrong. This can confound empirical methods that assume rational expectations.
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Bibliographic InfoPaper provided by Institute for Advanced Studies in its series Economics Series with number 300.
Length: 28 pages
Date of creation: Jul 2013
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-07-28 (All new papers)
- NEP-MIC-2013-07-28 (Microeconomics)
- NEP-UPT-2013-07-28 (Utility Models & Prospect Theory)
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Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:
- Empirics under uncertain beliefs are difficult
by Economic Logician in Economic Logic on 2013-09-20 14:51:00
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