Structured ambiguity and model misspecification

Lars Peter Hansen, Thomas J. Sargent

    Research output: Contribution to journalArticlepeer-review

    Abstract

    A decision maker is averse to not knowing a prior over a set of restricted structured models (ambiguity) and suspects that each structured model is misspecified. The decision maker evaluates intertemporal plans under all of the structured models and, to recognize possible misspecifications, under unstructured alternatives that are statistically close to them. Likelihood ratio processes are used to represent unstructured alternative models, while relative entropy restricts a set of unstructured models. A set of structured models might be finite or indexed by a finite-dimensional vector of unknown parameters that could vary in unknown ways over time. We model such a decision maker with a dynamic version of variational preferences and revisit topics including dynamic consistency and admissibility.

    Original languageEnglish (US)
    Article number105165
    JournalJournal of Economic Theory
    DOIs
    StateAccepted/In press - 2021

    Keywords

    • Ambiguity
    • Misspecification
    • Relative entropy
    • Robustness
    • Structured and unstructured models
    • Variational preferences

    ASJC Scopus subject areas

    • Economics and Econometrics

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