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CRETA Seminar - Giacomo Lanzani (Harvard)
Title: Dynamic Concern for Misspecification
Abstract: We consider an agent who posits a set of probabilistic models for the
payoff-relevant outcomes. The agent has a prior over this set but fears the
actual model is omitted and hedges against this possibility. The concern for
misspecification is endogenous: If a model explains the previous
observations well, the concern attenuates. We show that different static
preferences under uncertainty (subjective expected utility, maxmin, robust
control) arise in the long run, depending on how quickly the agent becomes
unsatisfied with unexplained evidence and whether they are misspecified. The
misspecification concern's endogeneity naturally induces behavior cycles,
and we characterize the limit action frequency. This model is consistent
with the evidence on monetary policy cycles and choices in the face of
complex tax schedules.