Research Publication

Investors face uncertainty over models when they do not know which member of a set of well-defined “structured models” is best. They face uncertainty about mod-els when they suspect that all of the structured models might be misspecified. We refer to worries about the first type of ignorance as ambiguity concerns and worries about the second type as misspecification concerns. These two types of ignorance about probability distributions of risks add what we call uncertainty components to equilibrium prices of those risks. A quantitative example highlights a representa-tive investor’s uncertainties about the size and persistence of macroeconomic growth rates. Our model of preferences under concerns about model ambiguity and misspec-ification puts nonlinearities into marginal valuations that induce time variations in market prices of uncertainty. These reflect the representative investor’s fears of high persistence of low growth rate states and low persistence of high growth rate states.

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For the Non-Expert:

Vox EU: Acknowledging and pricing macroeconomic uncertainties by Lars Peter Hansen and Thomas J. Sargent

@article{hansen2021macroeconomic,
  title={Macroeconomic uncertainty prices when beliefs are tenuous},
  author={Hansen, Lars Peter and Sargent, Thomas J},
  journal={Journal of Econometrics},
  volume={223},
  number={1},
  pages={222--250},
  year={2021},
  publisher={Elsevier}
}