A decision maker expresses ambiguity about statistical models in the following ways. He has a family of structured parametric probability models but suspects that their parameters vary over time in unknown ways that he does not describe probabilis- tically. He expresses a further suspicion that all of these parametric models are misspecified by entertaining alternative unstructured probability distributions that he represents only as positive martingales and that he restricts to be statistically close to the structured parametric models. Because he is averse to ambiguity, he uses a max-min criterion to evaluate alternative plans. We characterize equilibrium uncertainty prices by confronting a decision maker with a portfolio choice problem. We offer a quantitative illustration for structured parametric models that focus uncertainty on macroeconomic growth and its persistence. There emerge nonlinearities in marginal valuations that induce time variation in market prices uncertainty. Prices of uncertainty fluctuate because the investor especially fears high persistence in bad states and low persistence in good ones.
December 2016 | Working Paper
Tags: Econometrics, Financial Market Linkages to the Macroeconomy, Uncertainty and Valuation|