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Decision making in times of Knightian uncertainty: An info-gap perspective

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  • Ben-Haim, Yakov
  • Demertzis, Maria

Abstract

The distinction of risk vs uncertainty as made by Knight has important implications for policy selection. Assuming the former when the latter is relevant can lead to wrong decisions. With the aid of a stylized model that describes a bank's decision on how to allocate loans, the authors discuss policy insights for decision making under Knightian uncertainty. They use the info-gap robust satisficing approach to derive a trade-off between confidence and performance (analogous to confidence intervals in the Bayesian approach but without assignment of probabilities). The authors show that this trade off can be interpreted as a cost of robustness. They show that the robustness analysis can lead to a reversal of policy preference from the putative optimum. The authors then compare this approach to the min-max method which is the other main non-probabilistic approach available in the literature. They also consider conceptual proxies for robustness and demonstrate their use in qualitative analysis of financial architecture and monetary policy.

Suggested Citation

  • Ben-Haim, Yakov & Demertzis, Maria, 2016. "Decision making in times of Knightian uncertainty: An info-gap perspective," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 10, pages 1-30.
  • Handle: RePEc:zbw:ifweej:201623
    DOI: 10.5018/economics-ejournal.ja.2016-23
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    References listed on IDEAS

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    1. Yakov Ben-Haim & Maria Demertzis, 2008. "Confidence in Monetary Policy," DNB Working Papers 192, Netherlands Central Bank, Research Department.
    2. Christopher A. Sims, 2001. "Pitfalls of a Minimax Approach to Model Uncertainty," American Economic Review, American Economic Association, vol. 91(2), pages 51-54, May.
    3. Hildebrandt, Patrick & Knoke, Thomas, 2011. "Investment decisions under uncertainty--A methodological review on forest science studies," Forest Policy and Economics, Elsevier, vol. 13(1), pages 1-15, January.
    4. Herbert A. Simon, 1955. "A Behavioral Model of Rational Choice," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 69(1), pages 99-118.
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    Citations

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    Cited by:

    1. Yakov Ben‐Haim & Jan Willem Van den End, 2022. "Assessing uncertainty in the natural rate of interest: Info‐gap as guide for monetary policy in the euro area," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(3), pages 3228-3245, July.
    2. Mashor Housh & Tomer Aharon, 2021. "Info-Gap Models for Optimal Multi-Year Management of Regional Water Resources Systems under Uncertainty," Sustainability, MDPI, vol. 13(6), pages 1-27, March.
    3. Ben-Haim, Yakov & Demertzis, Maria & Van den End, Jan Willem, 2018. "Evaluating monetary policy rules under fundamental uncertainty: An info-gap approach," Economic Modelling, Elsevier, vol. 73(C), pages 55-70.
    4. Yakov Ben-Haim & Maria Demertzis & Jan Willem van den End, 2017. "Fundamental uncertainty and unconventional monetary policy- an info-gap approach," Working Papers 19317, Bruegel.
    5. Shira Daskal & Adar Ben-Eliyahu & Gal Levy & Yakov Ben-Haim & Ronnen Avny, 2022. "Earthquake Vulnerability Reduction by Building a Robust Social-Emotional Preparedness Program," Sustainability, MDPI, vol. 14(10), pages 1-22, May.
    6. Drudi, Francesco & Moench, Emanuel & Holthausen, Cornelia & Weber, Pierre-François & Ferrucci, Gianluigi & Setzer, Ralph & Adao, Bernardino & Dées, Stéphane & Alogoskoufis, Spyros & Téllez, Mar Delgad, 2021. "Climate change and monetary policy in the euro area," Occasional Paper Series 271, European Central Bank.
    7. Yakov Ben-Haim & Jan Willem van den End, 2019. "Fundamental uncertainty about the natural rate of interest: Info-gap as guide for monetary policy," DNB Working Papers 650, Netherlands Central Bank, Research Department.

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    More about this item

    Keywords

    uncertainty vs risk; confidence; robustness; satisficing; info-gap;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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