Optimal Preparation and Uncertainty Persistence

56 Pages Posted: 12 Mar 2018 Last revised: 18 Mar 2020

Date Written: August 13, 2018

Abstract

Unusual events trigger persistent spikes in uncertainty. Standard models cannot match these dynamic patterns. This paper presents a unified framework, motivated by the literature on inattention. Agents choose whether and how to prepare for different possible states of the world by collecting information. Agents optimally ignore sufficiently unlikely events, so the occurrence of such events does not resolve, but increases, uncertainty. Uncertain agents have dispersed beliefs, making it harder to focus future preparation. Thus, uncertainty begets uncertainty for an inattentive agent, endogenously persisting. In a financial application, this framework matches patterns in volatility, volume of trade, belief dispersion, and spreads.

Keywords: Inattention, Risk, Persistence, Uncertainty, Emergencies, Rare Events

JEL Classification: D80, D81, D83, G14

Suggested Citation

Sundaresan, Savitar, Optimal Preparation and Uncertainty Persistence (August 13, 2018). Available at SSRN: https://ssrn.com/abstract=3137806 or http://dx.doi.org/10.2139/ssrn.3137806

Savitar Sundaresan (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

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