"Robust Permanent Income and Pricing with Filtering"
Volume: 6 | Pages: 40-84
Publication type: Journal article
A planner and agent in a permanent-income economy cannot observe part of the state, regard their model as an approximation, and value decision rules that are robust across a set of models. They use robust decision theory to choose allocations. Equilibrium prices reflect the preference for robustness and so embody a ?market price of Knightian uncertainty.? We compute market prices of risk and compare them with a model that assumes that the state is fully observed. We use detection error probabilities to constrain a single parameter that governs the taste for robustness.
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