Heterogeneous Agent Economies With Knightian Uncertainty

This paper studies decentralized economies in which decision-makers do not have full knowledge of the probabilities of the states of nature. This ambiguity is referred to as Knightian uncertainty. Using a general equilibrium heterogeneous-agent model, we show how prices and consumption allocations are altered by the presence of Knightian uncertainty. It is known from previous work that models with Knightian uncertainty can have indeterminant security prices. In a multi-agent setup, we show the range of the indeterminacy is determined by the agents with the least amount of Knightian uncertainty. In contrast to models with `full risk-sharing', in a twoperiod setup we show consumption allocations have a threshold feature in which the consumptions of some individuals can be constant over a range of variations in the aggregate endowment. In an in nite-horizon setting, the threshold feature shows up in the expected utility values. Furthermore, consumption allocations in the random aggregate endowment economy are history-dependent. JEL: D50, D80, E21, G12 Address: Department of Economics, University of Washington, Box 353330, Seattle, WA 98195. Email: [email protected] This paper is a revision of my PhD dissertation at the University of Chicago. I am grateful to Tom Sargent, Robert Lucas, Grace Tsiang, Nancy Stokey, Jose Scheinkman, Gerald Cubbin, Evan Anderson, Andreas Lehnert, Geo rey Shuetrim, Tim Conley and Rose-Anne Dana for valuable comments and criticism on earlier drafts, and especially to Lars Hansen for guidance, encouragement and constant support. Financial support from the University of Chicago and Chiang Ching-Kuo Foundation is gratefully acknowledged. 1