Advertisement

Ambiguity and Economic Activity: Implications for the Current Crisis in Credit Markets

  • Sujoy Mukerji

Abstract

This chapter discusses some recent developments in economics regarding theories of decision making in conditions of uncertainty and argues that these new theories and models are singularly useful in explaining and understanding the ongoing credit crises. Moreover, it argues that the understanding based on these theories has significant policy implications about how the crises may be alleviated. While the formal articulation of these theories took place only recently, the ideas that formed their core had been discussed by Keynes1 and Knight2 in the 1920s. They had pointed out that for many important economic decisions, the decision maker (DM) faces “genuine” uncertainty such that he does not have reliable information about the relevant odds and that in such circumstances the uncertainty perceived by the DM may not be summarized by a single probability distribution, as in standard practice. It was also posited that a DM’s choice behavior would also be determined by his taking into account how much he knew about the relevant odds. In decision making under conditions of uncertainty it is often the case that the decision maker’s knowledge about the likelihood of contingent events is consistent with more than one probability distribution.

Keywords

Decision Maker Ambiguity Aversion Counterparty Risk Knightian Uncertainty Significant Policy Implication 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

Notes

  1. 1.
    Keynes, J.M. (1921): A Treatise on Probability, Macmillan, London.Google Scholar
  2. 2.
    Knight, F. (1921): Risk, Uncertainty and Profit, Kelly, New York.Google Scholar
  3. 3.
    Savage, L.J. (1972): The Foundations of Statistics, Dover, New York.Google Scholar
  4. 4.
    Ramsey, F.P. (1926): “Truth and Probability,” in Ramsey (1931), The Foundations of Mathematics and other Logical Essays, edited by R.B. Braithwaite, New York, Harcourt, Brace and Company; London, Kegan Paul, Trench, Trubner and Company, Ltd.,Ch. VII, pp. 156–198.Google Scholar
  5. 6.
    Ellsberg, D. (1963): “Risk, Ambiguity and the Savage Axioms,” Quarterly Journal of Economics, 75: pp. 643–669.CrossRefGoogle Scholar
  6. 8.
    Gilboa, I. and D. Schmeidler (1989): “Maxmin Expected Utility with a Non-Unique Prior,” Journal of Mathematical Economics, 18: pp. 141–153.CrossRefGoogle Scholar
  7. 10.
    Mukerji, S. and J.M. Tallon (2001): “Ambiguity Aversion and Incompleteness of Financial Markets,” Review of Economic Studies, 68: pp. 883–904.CrossRefGoogle Scholar
  8. 11.
    Caballero, R. J. and A. Krishnamurthy, (2008): “Collective Risk Management in a Flight to Quality Episode,” Journal of Finance, 63(5), pp. 2195–2230.CrossRefGoogle Scholar
  9. 13.
    Taylor, J. B. and J. C. Williams (2009): “Black Swan in the Money Market,” American Economic Journal Vol 1, issue 1, pp. 58–83.Google Scholar

Copyright information

© Robert Skidelsky and Christian Westerlind Wigström 2010

Authors and Affiliations

  • Sujoy Mukerji

There are no affiliations available

Personalised recommendations