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Fragile Beliefs and the Price of Model Uncertainty, working paper
, 2007
"... Concerns about misspecification and an enduring model selection problem in which one of the models has long run risks give rise to countercyclical risk premia. We use two risksensitivity operators to construct the stochastic discount factor for a representative consumer who evaluates consumption st ..."
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Cited by 53 (10 self)
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Concerns about misspecification and an enduring model selection problem in which one of the models has long run risks give rise to countercyclical risk premia. We use two risksensitivity operators to construct the stochastic discount factor for a representative consumer who evaluates consumption streams in light of model selection and parameter estimation problems that can aggravate or attenuate long run risks as time passes. The arrival of signals induces the consumer to alter his posterior distribution over models and parameters. The consumer copes with specification doubts by slanting probabilities pessimistically. These pessimistic model probabilities induce model uncertainty premia that contribute a timevarying component to what is ordinarily measured as the market price of risk.
Doubts or variability
 Journal of Economic Theory
"... Reinterpreting most of the market price of risk as a price of model uncertainty eradicates a link between asset prices and measures of the welfare costs of aggregate fluctuations that was proposed by Hansen et al. (1999), Tallarini (2000), and Alvarez and Jermann (2004). Prices of model uncertainty ..."
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Cited by 29 (3 self)
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Reinterpreting most of the market price of risk as a price of model uncertainty eradicates a link between asset prices and measures of the welfare costs of aggregate fluctuations that was proposed by Hansen et al. (1999), Tallarini (2000), and Alvarez and Jermann (2004). Prices of model uncertainty contain information about the benefits of removing model uncertainty, not the consumption fluctuations that Lucas (1987, 2003) studied. A maxmin expected utility theory lets us reinterpret Tallarini’s riskaversion parameter as measuring a representative consumer’s doubts about the model specification. We use model detection instead of riskaversion experiments to calibrate that parameter. Plausible values of detection error probabilities give prices of model uncertainty that approach the Hansen and Jagannathan (1991) bounds. Fixed detection error probabilities give rise to virtually identical asset prices as well as virtually identical costs of model uncertainty for Tallarini’s two models of consumption growth. Key words: Risk aversion, model misspecification, robustness, market price of risk, equity premium puzzle, riskfree rate puzzle, detection error probability, costs of model uncertainty.
Vector Expected Utility and Attitudes toward Variation
, 2007
"... This paper analyzes a model of decision under ambiguity, deemed vector expected utility or VEU. According to the proposed model, an act f: Ω → X is evaluated via the functional V (f) = ..."
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Cited by 28 (4 self)
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(Show Context)
This paper analyzes a model of decision under ambiguity, deemed vector expected utility or VEU. According to the proposed model, an act f: Ω → X is evaluated via the functional V (f) =
2010), "Fragile Beliefs and the Price of Uncertainty
 Quantitative Economics
"... A representative consumer uses Bayes ’ law to learn about parameters and to construct probabilities with which to perform ongoing model averaging. The arrival of signals induces the consumer to alter his posterior distribution over parameters and models. The consumer copes with specification doubts ..."
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Cited by 23 (4 self)
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A representative consumer uses Bayes ’ law to learn about parameters and to construct probabilities with which to perform ongoing model averaging. The arrival of signals induces the consumer to alter his posterior distribution over parameters and models. The consumer copes with specification doubts by slanting probabilities pessimistically. One of his models puts longrun risks in consumption growth. The pessimistic probabilities slant toward this model and contribute a countercyclical and signalhistorydependent component to prices of risk.
THE FUNDAMENTAL RISK QUADRANGLE IN RISK MANAGEMENT, OPTIMIZATION AND STATISTICAL ESTIMATION
, 2013
"... Random variables that stand for cost, loss or damage must be confronted in numerous situations. Dealing with them systematically for purposes in risk management, optimization and statistics is the theme of this presentation, which brings together ideas coming from many different areas. Measures of r ..."
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Cited by 15 (7 self)
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Random variables that stand for cost, loss or damage must be confronted in numerous situations. Dealing with them systematically for purposes in risk management, optimization and statistics is the theme of this presentation, which brings together ideas coming from many different areas. Measures of risk can be used to quantify the hazard in a random variable by a single value which can substitute for the otherwise uncertain outcomes in a formulation of constraints and objectives. Such quantifications of risk can be portrayed on a higher level as generated from penaltytype expressions of “regret ” about the mix of potential outcomes. A tradeoff between an upfront level of hazard and the uncertain residual hazard underlies that derivation. Regret is the mirror image of utility, a familiar concept for dealing with gains instead of losses, but regret concerns hazards relative to a benchmark. It bridges between risk measures and expected utility, thereby reconciling those two approaches to optimization under uncertainty Statistical estimation is inevitably a partner with risk management in handling hazards, which may be known only partially through a data base. However, a much deeper connection has come to light with statistical theory itself, in particular regression. Very general measures of error can
Subjective beliefs and exante trade
 ECONOMETRICA, VOL. 76, NO. 5 (SEPTEMBER, 2008), 1167–1190
, 2008
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A Simpli…ed Axiomatic Approach to Ambiguity Aversion, mimeo
, 2009
"... This paper takes the AnscombeAumann framework with horse and roulette lotteries, and applies the Savage axioms to the horse lotteries and the von NeumannMorgenstern axioms to the roulette lotteries. The resulting representation of preferences yields a subjective probability measure over states an ..."
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Cited by 7 (0 self)
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This paper takes the AnscombeAumann framework with horse and roulette lotteries, and applies the Savage axioms to the horse lotteries and the von NeumannMorgenstern axioms to the roulette lotteries. The resulting representation of preferences yields a subjective probability measure over states and two utility functions, one governing risk attitudes and one governing ambiguity attitudes. The model is able to accommodate the Ellsberg paradox and preferences for reductions in ambiguity.
Status quo bias, multiple priors and uncertainty aversion
 Games and Economic Behavior
, 2010
"... Abstract. Motivated by the extensive evidence about the relevance of status quo bias both in experiments and in real markets, we study this phenomenon from a decisiontheoretic prospective, focusing on the case of preferences under uncertainty. We develop an axiomatic framework that takes as a primi ..."
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Cited by 6 (2 self)
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Abstract. Motivated by the extensive evidence about the relevance of status quo bias both in experiments and in real markets, we study this phenomenon from a decisiontheoretic prospective, focusing on the case of preferences under uncertainty. We develop an axiomatic framework that takes as a primitive the preferences of the agent for each possible status quo option, and provide a characterization according to which the agent prefers her status quo act if nothing better is feasible for a given set of possible priors. We then show that, in this framework, the very presence of a status quo induces the agent to be more uncertainty averse than she would be without a status quo option. Finally, we apply the model to a financial choice problem and show that the presence of status quo bias as modeled here might induce the presence of a risk premium even with risk neutral agents. JEL classification: D11, D81.
Managing pessimistic expectations and fiscal policy
, 2011
"... This paper studies the design of optimal fiscal policy when a government that fully trusts the probability model of government expenditures faces a fearful public that forms pessimistic expectations. We identify two forces that shape our results. On the one hand, the government has an incentive to c ..."
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Cited by 5 (2 self)
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This paper studies the design of optimal fiscal policy when a government that fully trusts the probability model of government expenditures faces a fearful public that forms pessimistic expectations. We identify two forces that shape our results. On the one hand, the government has an incentive to concentrate tax distortions on events that it considers unlikely relative to the pessimistic public. On the other hand, the endogeneity of the public’s expectations gives rise to a novel motive for expectation management that aims towards the manipulation of equilibrium prices of government debt in a favorable way. These motives typically act in opposite directions and induce persistence to the optimal allocation and the tax rate.