A decision-based approach to econometric modelling∗

In many applications it is necessary to use a simple and therefore highly misspecified econometric model as the basis for decision-making. We propose an approach to developing a possibly misspecified econometric model that will be used as the beliefs of an expected utility maximiser. An objective function that measures the value of predictive distributions in decision-making is introduced and used in estimation, selection and evaluation of parametric or semiparametric models. The methods proposed also provide an econometric approach for developing arbitrary parametric action rules such as technical trading rules. The approach is compared in detail with existing methods and is applied in the context of a CARA investor’s decision problem where analytical, simulation and empirical results suggest it is very effective.