Working Paper: NBER ID: w25781
Authors: Lars Peter Hansen; Thomas J. Sargent
Abstract: A representative investor does not know which member of a set of well-defined parametric "structured models'' is best. The investor also suspects that all of the structured models are misspecified. These uncertainties about probability distributions of risks give rise to components of equilibrium prices that differ from the risk prices widely used in asset pricing theory. A quantitative example highlights a representative investor's uncertainties about the size and persistence of macroeconomic growth rates. Our model of preferences under ambiguity puts nonlinearities into marginal valuations that induce time variations in market prices of uncertainty. These arise because the representative investor especially fears high persistence of low growth rate states and low persistence of high growth rate states.
Keywords: Macroeconomic Uncertainty; Asset Pricing; Investor Behavior; Model Uncertainty
JEL Codes: C52; C58; D81; D84; E7; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Investor's uncertainty about macroeconomic growth rates (D89) | Time-varying market prices of uncertainty (G19) |
| Investor's fear of high persistence of low growth rates (D25) | Time-varying market prices of uncertainty (G19) |
| Investor's fear of low persistence of high growth rates (D25) | Time-varying market prices of uncertainty (G19) |
| Investor's evaluation of structured models (C52) | Introduction of unstructured models (C29) |
| Economic conditions (E66) | Shadow prices (P22) |
| Shadow prices (P22) | Market's compensation for bearing model uncertainty (D81) |