The choice between multiplicative and additive production uncertainty
When 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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Discussion Paper Series, Department of Economics
200301, Department of Economics, University of St. Andrews.
- Moavia Alghalith, 2003. "Empirical Analysis under Additive/Multiplicative Output Uncertainty," CRIEFF Discussion Papers 0301, Centre for Research into Industry, Enterprise, Finance and the Firm.
- Viaene, Jean-Marie & Zilcha, Itzhak, 1998. "The Behavior of Competitive Exporting Firms under Multiple Uncertainty," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 591-609, August.
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- Moavia Alghalith, 2003. "Estimation and Econometric Tests Under Simultaneous Price and Output Uncertainty," CRIEFF Discussion Papers 0302, Centre for Research into Industry, Enterprise, Finance and the Firm.
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