A Bayesian model of Knightian uncertainty

Nabil I. Al-Najjar*, Jonathan Weinstein

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

10 Scopus citations

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.

Original languageEnglish (US)
Pages (from-to)1-22
Number of pages22
JournalTheory and Decision
Volume78
Issue number1
DOIs
StatePublished - Jan 2013

Keywords

  • Knightian uncertainty
  • Risk

ASJC Scopus subject areas

  • Decision Sciences(all)
  • Developmental and Educational Psychology
  • Arts and Humanities (miscellaneous)
  • Applied Psychology
  • Social Sciences(all)
  • Economics, Econometrics and Finance(all)
  • Computer Science Applications

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