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Ambiguous Business Cycles

  • Cosmin Ilut
  • Martin Schneider

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
Date of revision:
Publication status: published as \Ambiguous Business Cycles", with Martin Schneider, American Economic Review, forthcoming
Handle: RePEc:nbr:nberwo:17900
Note: EFG ME
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