Robust Permanent Income and Pricing with Filtering
Coauthor(s): Lars Hansen, Thomas Sargent.
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.
Source: Macroeconomic Dynamics
Hansen, Lars, Thomas Sargent, and Neng Wang. "Robust Permanent Income and Pricing with Filtering." Macroeconomic Dynamics 6 (2002): 40-84.