Becker Friedman Institute
for Research in Economics
The University of Chicago

Research. Insights. Impact. Advancing the Legacy of Chicago Economics.

Robustness and Ambiguity in Continuous Time

May 2011
Lars Peter Hansen, Thomas J. Sargent

We use statistical detection theory in a continuous-time environment to provide a new perspective on calibrating a concern about robustness or an aversion to ambiguity. A decision maker repeatedly confronts uncertainty about state transition dynamics and a prior distribution over unobserved states or parameters. Two continuous-time formulations are counterparts of two discrete-time recursive specifications of Hansen and Sargent (2007) [16]. One formulation shares features of the smooth ambiguity model of Klibanoff et al. (2005) and (2009) [24] and [25]. Here our statistical detection calculations guide how to adjust contributions to entropy coming from hidden states as we take a continuous-time limit.

Journal of Economic Theory
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