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Ambiguous Business Cycles

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  • Cosmin Ilut
  • Martin Schneider

Abstract

This paper considers business cycle models with agents who dislike both risk and ambiguity (Knightian uncertainty). Ambiguity aversion is described by recursive multiple priors preferences that capture agents' lack of confidence in probability assessments. While modeling changes in risk typically requires higher-order approximations, changes in ambiguity in our models work like changes in conditional means. Our models thus allow for uncertainty shocks but can still be solved and estimated using first-order approximations. In our estimated medium-scale DSGE model, a loss of confidence about productivity works like 'unrealized' bad news. Time-varying confidence emerges as a major source of business cycle fluctuations.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17900.

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Date of creation: Mar 2012
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Publication status: published as \Ambiguous Business Cycles", with Martin Schneider, American Economic Review, forthcoming
Handle: RePEc:nbr:nberwo:17900

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  1. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  2. Fernández-Villaverde, Jesús & Rubio-Ramirez, Juan Francisco, 2006. "Estimating Macroeconomic Models: A Likelihood Approach," CEPR Discussion Papers 5513, C.E.P.R. Discussion Papers.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  4. Marco Cagetti & Lars Peter Hansen & Thomas Sargent & Noah Williams, 2002. "Robustness and Pricing with Uncertain Growth," Review of Financial Studies, Society for Financial Studies, vol. 15(2), pages 363-404, March.
  5. Ruediger Bachmann & Steffen Elstner & Eric R. Sims, 2010. "Uncertainty and Economic Activity: Evidence from Business Survey Data," NBER Working Papers 16143, National Bureau of Economic Research, Inc.
  6. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  7. Susanto Basu & Brent Bundick, 2012. "Uncertainty Shocks in a Model of Effective Demand," NBER Working Papers 18420, National Bureau of Economic Research, Inc.
  8. Giorgio E. Primiceri & Andrea Tambalotti & Alejandro Justiniano, 2009. "Investment Shocks and the Relative Price of Investment," 2009 Meeting Papers 686, Society for Economic Dynamics.
  9. Lars Peter Hansen & Thomas J. Sargent & Thomas D. Tallarini Jr., 1997. "Robust Permanent Income and Pricing," Levine's Working Paper Archive 596, David K. Levine.
  10. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March.
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  1. Ambiguous Business Cycles
    by Christian Zimmermann in NEP-DGE blog on 2012-06-09 20:57:11
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Cited by:
  1. Matthew Smith & Rhys Bidder, 2013. "Robust Animal Spirits," 2013 Meeting Papers 265, Society for Economic Dynamics.
  2. Nicholas Bloom, 2014. "Fluctuations in Uncertainty," Journal of Economic Perspectives, American Economic Association, vol. 28(2), pages 153-76, Spring.
  3. Adrian Pagan, 2013. "Patterns and Their Uses," NCER Working Paper Series 96, National Centre for Econometric Research.
  4. Thorsten Drautzburg & Harald Uhlig, 2011. "Fiscal Stimulus and Distortionary Taxation," 2011 Meeting Papers 481, Society for Economic Dynamics.
  5. Larry G. Epstein & Shaolin Ji, 2012. "Ambiguous Volatility and Asset Pricing in Continuous Time," CIRANO Working Papers 2012s-29, CIRANO.
  6. Tony Hall & Jan Jacobs & Adrian Pagan, . "Macro-Econometric System Modelling @75," NCER Working Paper Series 95, National Centre for Econometric Research.
  7. Lars Hansen & Jaroslav Borovicka, 2013. "Robust preference expansions," 2013 Meeting Papers 1199, Society for Economic Dynamics.
  8. Erzo G.J. Luttmer, 2013. "The Stolper-Samuelson effects of a decline in aggregate consumption," Working Papers 703, Federal Reserve Bank of Minneapolis.
  9. Lars Peter Hansen, 2012. "Risk Pricing over Alternative Investment Horizons," Working Papers 2012-008, Becker Friedman Institute for Research In Economics.
  10. Mayumi Ojima & Junnosuke Shino & Kozo Ueda, 2014. "Buyer-Size Discounts and Inflation Dynamics," UTokyo Price Project Working Paper Series 017, University of Tokyo, Graduate School of Economics.

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