Robust permanent income and pricing with filtering

Lars Peter Hansen, Thomas J. Sargent, Neng E. Wang

    Research output: Contribution to journalArticlepeer-review

    Abstract

    A planner and agent in a permanent-income economy cannot observe part of the state, regard their model as an approximation, and value decision rules that are robust across a set of models. They use robust decision theory to choose allocations. Equilibrium prices reflect the preference for robustness and so embody a "market price of Knightian uncertainty." We compute market prices of risk and compare them with a model that assumes that the state is fully observed. We use detection error probabilities to constrain a single parameter that governs the taste for robustness.

    Original languageEnglish (US)
    Pages (from-to)40-84
    Number of pages45
    JournalMacroeconomic Dynamics
    Volume6
    Issue number1
    DOIs
    StatePublished - Feb 2002

    Keywords

    • Approximating Model
    • Equity Premium
    • Kalman Filter
    • Knightian Uncertainty
    • Market Price of Uncertainty
    • Permanent Income
    • Robustness

    ASJC Scopus subject areas

    • Economics and Econometrics

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