NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Ambiguous Business Cycles

Cosmin Ilut, Martin Schneider

NBER Working Paper No. 17900
Issued in March 2012
NBER Program(s):   EFG   ME

This paper considers business cycle models with agents who dislike both risk and ambiguity (Knightian uncertainty). Ambiguity aversion is described by recursive multiple priors preferences that capture agents' lack of confidence in probability assessments. While modeling changes in risk typically requires higher-order approximations, changes in ambiguity in our models work like changes in conditional means. Our models thus allow for uncertainty shocks but can still be solved and estimated using first-order approximations. In our estimated medium-scale DSGE model, a loss of confidence about productivity works like 'unrealized' bad news. Time-varying confidence emerges as a major source of business cycle fluctuations.

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Document Object Identifier (DOI): 10.3386/w17900

\Ambiguous Business Cycles", with Martin Schneider, American Economic Review, forthcoming citation courtesy of

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