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 explore the economic implications when uncertainty is more broadly conceived than is typical in economic analyses. To investigate this requires a modeling framework where decision-makers sometimes struggle with how to make projections about the future. Hansen and his coauthors propose and justify ways to represent prudent decision making in the presence of different forms of uncertainty, including risk within a model, ambiguity across models, and the potential misspecification of each such model. This research is a precursor to the study of the impact of broadly-based uncertainty on financial markets, economic outcome, and astute 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, May 2022.
- “Risk, Ambiguity, and Misspecification: Decision Theory, Robust Control, and Statistics,” (with Thomas J. Sargent), January 2023.
2. Implications of macroeconomic uncertainty for market and social valuation
Formal and informal evidence from financial markets suggests that the markets vary over time in their concerns about uncertainty. What exactly drives these fluctuations, and how are they related to speculations about future macroeconomic performance? Relatedly, how should public policy be most effectively designed given our incomplete understanding of how such policies impacts the economy? Hansen’s joint work with his collaborators advances our understanding of the answers to these important questions.
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 their exposure to macroeconomic uncertainty, and the impact of this uncertainty compounds over time. The nature or form of this uncertainty can impact the implied market valuations. Hansen and his collaborators are advancing our understanding of what the sources are of these market compensations, and what exactly makes the compensations fluctuate over time. This research includes a drive to identify and understand better the uncertainties that persist over time as well as what their impact is on even short-term valuation.
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) forthcoming in the Journal of Economic Theory, June 2022.
Social Valuation
Hansen and his collaborators build on ideas in 1) Struggling with a complex and uncertain future and elsewhere by developing and applying various methods for confronting uncertainty and its consequences when formulating prudent public policy design and assessing alternative courses of action. This research brings tools from decision theory and asset pricing to study uncertainty valuation, including the ramifications for the social cost of carbon in the study of climate change. Specifically, Hansen’s research emphasizes how to make quantitative modeling a credible input to conduct policy analysis in dynamic settings when our knowledge base is limited. It combines so-called “stylized modeling” with empirical evidence while seeking to recognize the limits of each.
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.
3. Investor beliefs as revealed by asset market data
Asset markets are fundamentally forward-looking. They encode information related to investors’ beliefs about the future and about investors’ concerns for the underlying uncertainty. How can we use financial market data to extract information about these two components in a reliable way? Financial market prices can change because investors change their subjective beliefs about the future and because the risk prices that they are exposed to change. This research, which Hansen pursues with his collaborators, investigates this question by formally exploring the interplay between investors’ beliefs, the statistical challenges that market participants confront, and the long-term consequences of exposures 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), November 2020.
- “Robust Inference for Moment Condition Models without Rational Expectations,” (with Xiaohong Chen and Peter G. Hansen), SSRN working paper, October 2021.