Ambiguity and Unemployment Fluctuations

Abstract

We analyze the consequences of ambiguity aversion in the Diamond-Mortensen-Pissarides (DMP) search and matching model. Our model features a cross-section of workers whose productivity contain a match-specific component. Firms are ambiguity averse towards match-specific productivity. Our model delivers two insights. First, we show that ambiguity aversion substantially amplifies unemployment rate volatility. Second, we show that a part of the high value of leisure required by the canonical DMP model to generate realistic unemployment rate volatility can arise from fitting a model missing ambiguity aversion to data generated in an environment where agents are ambiguity averse.

Keywords: Ambiguity, model uncertainty, robustness, unemployment, labor search.

JEL Classification: D81, E24, E32, J63, J64