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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 con fidence 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 confi dence about productivity works like `unrealized' bad news. Time-varying con fidence emerges as a major source of business cycle fluctuations.

Suggested Citation

  • Cosmin Ilut & Martin Schneider, 2012. "Ambiguous Business Cycles," Working Papers 12-06, Duke University, Department of Economics.
  • Handle: RePEc:duk:dukeec:12-06
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    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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