Optimal Preparation and Uncertainty Persistence
56 Pages Posted: 12 Mar 2018 Last revised: 18 Mar 2020
Date Written: August 13, 2018
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: Suggested Citation