Utility Based Model Selection and Model Averaging
28 Pages Posted: 12 Sep 2019
Date Written: September 4, 2019
This paper presents a novel approach to model selection and model averaging based on economic theory. We study model prediction in the form of a distributional opinion about a random variable X. We show how to test this prediction against alternative views. Different model opinions can be traded on a hypothetical market that trades their differences. Using a utility maximization technique, we describe such a market for any general random variable X and any utility function U. We specify the optimal behavior of agents and the total market that aggregates all available opinions and show that a correct distributional opinion realizes profit in expectation against any other opinion, giving a novel technique for model selection. Analytical solutions are available for random variables from the exponential family. We determine the distribution corresponding to the aggregated view of all available opinions, giving a novel technique for model averaging.
Keywords: Utility Maximization, Explicit Demand Function, Equilibrium, Exponential Family, Model Selection, Model Averaging
JEL Classification: C52, C68, D58, G13
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