A Bayesian model of Knightian uncertainty

Theory and Decision 78 (1):1-22 (2015)
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Abstract

A long tradition suggests a fundamental distinction between situations of risk, where true objective probabilities are known, and unmeasurable uncertainties where no such probabilities are given. This distinction can be captured in a Bayesian model where uncertainty is represented by the agent’s subjective belief over the parameter governing future income streams. Whether uncertainty reduces to ordinary risk depends on the agent’s ability to smooth consumption. Uncertainty can have a major behavioral and economic impact, including precautionary behavior that may appear overly conservative to an outside observer. We argue that one of the main characteristics of uncertain beliefs is that they are not empirical, in the sense that they cannot be objectively tested to determine whether they are right or wrong. This can confound empirical methods that assume rational expectations.

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Citations of this work

The Irrelevance of the Risk-Uncertainty Distinction.Dominic Roser - 2017 - Science and Engineering Ethics 23 (5):1387-1407.

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References found in this work

Risk, Uncertainty and Profit.Frank H. Knight - 1921 - University of Chicago Press.
Maxmin expected utility with non-unique prior.Itzhak Gilboa & David Schmeidler - 1989 - Journal of Mathematical Economics 18 (2):141–53.
The General Theory of Employment.John Maynard Keynes - 1937 - Quarterly Journal of Economics 51:209-223.

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