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Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty

Author

Listed:
  • Rosen Valchev

    (Duke University)

  • Nicolas Vincent

    (HEC Montréal)

  • Cosmin Ilut

    (Duke University)

Abstract

We propose a new theory of price rigidity based on firms’ Knightian uncertainty about their competitive environment. This uncertainty has two key implications. First, firms learn about the shape of their demand function from past observations of quantities sold. This learning gives rise to kinks in the expected profit function at previously observed prices, making those prices both sticky and more likely to reoccur. Second, uncertainty about the relationship between aggregate and industry-level inflation generates nominal rigidity. We prove the main insights analytically and quantify the effects of our mechanism. Our estimated quantitative model is consistent with a wide range of micro-level pricing facts that are typically challenging to match jointly. It also implies significantly more persistent monetary non-neutrality than in standard models, allowing it to generate large real effects from nominal shocks.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Rosen Valchev & Nicolas Vincent & Cosmin Ilut, 2014. "Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty," 2014 Meeting Papers 716, Society for Economic Dynamics.
    • Handle: RePEc:red:sed014:716
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    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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