Aversion to ambiguity and model misspecification in dynamic stochastic environments
Hansen, Lars Peter
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Citation (published version)Lars Peter Hansen, Jianjun Miao. 2018. "Aversion to ambiguity and model misspecification in dynamic stochastic environments." Proceedings of the National Academy of Sciences, Volume 115, Issue 37, pp. 9163 - 9168. https://doi.org/10.1073/pnas.1811243115
Preferences that accommodate aversion to subjective uncertainty and its potential misspecification in dynamic settings are a valuable tool of analysis in many disciplines. By generalizing previous analyses, we propose a tractable approach to incorporating broadly conceived responses to uncertainty. We illustrate our approach on some stylized stochastic environments. By design, these discrete time environments have revealing continuous time limits. Drawing on these illustrations, we construct recursive representations of intertemporal preferences that allow for penalized and smooth ambiguity aversion to subjective uncertainty. These recursive representations imply continuous time limiting Hamilton–Jacobi–Bellman equations for solving control problems in the presence of uncertainty.
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