Robust control of forward-looking models

Lars Peter Hansen, Thomas J. Sargent

    Research output: Contribution to journalArticlepeer-review

    Abstract

    This paper shows how to formulate and compute robust Ramsey (aka Stackelberg) plans for linear models with forward-looking private agents. The leader and the followers share a common approximating model and both have preferences for robust decision rules because both doubt the model. Since their preferences differ, the leader's and followers' decision rules are fragile to different misspecifications of the approximating model. We define a Stackelberg equilibrium with robust decision makers in which the leader and follower have different worst-case models despite sharing a common approximating model. To compute a Stackelberg equilibrium we formulate a Bellman equation that is associated with an artificial single-agent robust control problem. The artificial Bellman equation contains a description of implementability constraints that include Euler equations that describe the worst-case analysis of the followers. As an example, the paper analyzes a model of a monopoly facing a competitive fringe.

    Original languageEnglish (US)
    Pages (from-to)581-604
    Number of pages24
    JournalJournal of Monetary Economics
    Volume50
    Issue number3
    DOIs
    StatePublished - Apr 2003

    Keywords

    • Forward looking models

    ASJC Scopus subject areas

    • Finance
    • Economics and Econometrics

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