Ambiguous Business Cycles

54 Pages Posted: 10 Mar 2012 Last revised: 31 May 2023

Multiple version iconThere are 2 versions of this paper

Date Written: March 2012

Abstract

This paper considers business cycle models with agents who dislike both risk and ambiguity (Knightian uncertainty). Ambiguity aversion is described by recursive multiple priors preferences that capture agents' lack of confidence in probability assessments. While modeling changes in risk typically requires higher-order approximations, changes in ambiguity in our models work like changes in conditional means. Our models thus allow for uncertainty shocks but can still be solved and estimated using first-order approximations. In our estimated medium-scale DSGE model, a loss of confidence about productivity works like 'unrealized' bad news. Time-varying confidence emerges as a major source of business cycle fluctuations.

Suggested Citation

Ilut, Cosmin L. and Schneider, Martin, Ambiguous Business Cycles (March 2012). NBER Working Paper No. w17900, Available at SSRN: https://ssrn.com/abstract=2019399

Cosmin L. Ilut (Contact Author)

Duke University ( email )

100 Fuqua Drive
Durham, NC 27708-0204
United States

HOME PAGE: http://econ.duke.edu/~cli2/index.html

Martin Schneider

Stanford University ( email )

Stanford, CA 94305
United States