Lars Peter Hansen is a leading expert in economic dynamics who works at the forefront of economic thinking and modeling. He draws approaches from macroeconomics, finance, and statistics.
Hansen’s current work investigates three interconnecting areas: (1) struggling with a complex and uncertain future; (2) implications of macroeconomic uncertainty for market and social valuation; and (3) understanding investor beliefs through asset market data
In this 4-minute documentary, “Incertitudes”, Lars explains why he seeks to better understand the role uncertainty plays in financial markets and the economy. (Produced by Histoire courtes.)
1. Struggling with a complex and uncertain future
Hansen and his collaborators examine the economic consequences of uncertainty when defined more broadly than in traditional economic analyses. Their work requires a modeling framework in which decision-makers face challenges in projecting the future. Hansen and his coauthors propose and justify approaches for representing prudent decision-making under various forms of uncertainty, including model-specific risk, ambiguity across models, and potential model misspecification. This research lays the groundwork for understanding the broader effects of uncertainty on financial markets, economic outcomes, and informed policymaking.
Relevant Research
- “Four Types of Ignorance,” (with Thomas J. Sargent) published in the Journal of Monetary Economics, January 2015.
- “Ambiguity Aversion and Model Misspecification: An Economic Perspective,” (with Massimo Marinacci), published in Statistical Science, January 2017.
- “Aversion to Ambiguity and Model Misspecification in Dynamic Stochastic Environments,” (with Jianjun Miao) published in the Proceedings of the National Academy of Sciences, August 2018.
- “Structured Ambiguity and Model Misspecification,” (with Thomas J. Sargent), published in the Journal of Economic Theory, January 2022.
- “Making Decisions Under Model Misspecification,” (with Simone Cerreia–Vioglio, Fabio Maccheroni and Massimo Marinacci), SSRN, April 2024.
- “Risk, Ambiguity, and Misspecification: Decision Theory, Robust Control, and Statistics,” (with Thomas J. Sargent), published in the Journal of Applied Econometrics, September 2023.
- “Robust Inattentive Discrete Choice,” (with Jianjun Miao and Hao Xing), SSRN Working Paper, August 2024.
2. Implications of macroeconomic uncertainty for market and social valuation
Both formal and informal evidence from financial markets indicate that concerns about uncertainty fluctuate over time. But what drives these changes, and how are they connected to expectations of future macroeconomic performance? Moreover, how can public policy be most effectively crafted, given our incomplete understanding of its economic impacts? Hansen’s collaborative work advances our understanding of these critical questions, shedding light on the complex relationship between market uncertainty and policymaking.
The following paper is a survey of this strand of research:
- “Uncertainty Spillovers for Markets and Policy,” by Lars Peter Hansen published in the Annual Review of Economics, August, 2021.
Market Valuation
Investors in financial markets are compensated for bearing macroeconomic uncertainty, with its effects compounding over time. The specific nature of this uncertainty can significantly influence market valuations. Hansen and his collaborators are deepening our understanding of the sources behind these compensations and what causes them to fluctuate over time. Their research seeks to identify and better understand the uncertainties that persist in the long run and how they impact even short-term valuations.
Relevant Research
- “Dynamic Valuation Decomposition Within Stochastic Economies,” Econometrica 80 (May 2012): 911-967.
- “Shock Elasticities and Impulse Responses,” (with Jaroslav Borovika and Jose A. Scheinkman), Mathematics and Financial Economics 8 (September 2014): 333-354.
- “Examining Macroeconomic Models Through the Lens of Asset Pricing,” (with Jaroslav Borovicka), Journal of Econometrics 183 (November 2014): 67-90.
- “Term Structure of Uncertainty in the Macroeconomy,” (with Jaroslav Borovicka), Handbook of Macroeconomics: Volume 2B (2016) Chapter 20, Elsevier B.V., 1641–1696. [Discussion for the Non-Expert]
- “Twisted Probabilities, Uncertainty, and Prices,” (with Bálint Szőke, Lloyd S. Han, and Thomas J. Sargent) published in the Journal of Econometrics, February 2020.
- “Macroeconomic Uncertainty Prices When Beliefs are Tenuous,” (with Thomas J. Sargent) published in the Journal of Econometrics, July 2021.
- “Asset Pricing under Smooth Ambiguity in Continuous Time,” (with Jianjun Miao) published in the Journal of Economic Theory, June 2022.
- “Comparative Valuation Dynamics in Production Economies: Long-run Uncertainty, Heterogeneity, and Market Frictions,” (with Paymon Khorrami and Fabrice Tourre), forthcoming in the Annual Review of Financial Economics.
Social Valuation
Hansen and his collaborators expand on ideas from Struggling with a Complex and Uncertain Future and other works by developing and applying methods to address uncertainty and its consequences in the formulation of prudent public policy and the evaluation of alternative actions. Their research draws on tools from decision theory and asset pricing to explore the valuation of uncertainty, including its implications for the social cost of carbon in climate change analysis and social value of research and development. Hansen’s work highlights the importance of making quantitative models a credible tool for policy analysis in dynamic settings where our knowledge is limited. This approach combines “stylized modeling” with empirical evidence, while carefully acknowledging the limitations of both.
Relevant Research
- “Purely Evidence Based Policy Does Not Exist,” by Lars Peter Hansen, published in the Chicago Booth Review, February 2018.
- “Pricing Uncertainty Induced by Climate Change,” (with William ‘Buz’ Brock and Michael Barnett), published in the Review of Financial Studies, February 2020.
- “Rational Policymaking During a Pandemic,” (with Loic Berger, Nicolas Berger, Valentina Bosetti, Itzhak Gilboa, Christopher Jarvis, Massimo Marinacci and Richard D. Smith), published in the Proceedings of the National Academy of Sciences, January, 2021.
- “Central Banking Challenges Posed by Uncertain Climate Change and Natural Disasters,” published in the Journal of Monetary Economics, January 2022.
- “Climate Change Uncertainty Spillover in the Macroeconomy,” (with Michael Barnett and William Brock), published in the NBER Macroeconomics Annual, May 2022.
- “Confronting Uncertainty in Climate Policy,” by Lars Peter Hansen, published in the Chicago Booth Review, July 2022.
- “Carbon Prices and Forest Preservation Over Space and Time in the Brazilian Amazon,” (with Juliano J. Assunção, Todd Munson and José A. Scheinkman), SSRN Working Paper, February 2024.
- “Uncertainty, Social Valuation, and Climate Change Policy,” (with Michael Barnett, William Brock and Hong Zhang), SSRN Working Paper, September 2024.
3. Investor beliefs as revealed by asset market data
Asset markets are inherently forward-looking, embedding information about investors’ expectations for the future and their concerns about underlying uncertainty. But how can we reliably extract insights about these two components from financial market data? Market prices fluctuate not only due to shifts in investors’ beliefs about the future but also because of changes in the risks they face. Hansen, along with his collaborators, investigates this by formally examining the relationship between investors’ beliefs, the statistical challenges faced by market participants, and the long-term consequences of exposure to uncertainty.
Relevant Research
- “Uncertainty Inside and Outside Economic Models,” (Lars Peter Hansen’s Nobel Prize lecture), Journal of Political Economy, July 2014.
- “Misspecified Recovery,” (with Jaroslav Borovička and José A. Scheinkman), Journal of Finance, December 2016, [Remarks on Identification, Recovery and Martingales]
- “Robust Identification of Investor Beliefs,” (with Xiaohong Chen and Peter G. Hansen), published in the Proceedings of the National Academy of Sciences (PNAS), 2020.
- “Robust Inference for Moment Condition Models without Rational Expectations,” (with Xiaohong Chen and Peter G. Hansen), published in the Journal of Econometrics), January 2024.