Type: Working Paper
Nested Models and Model Uncertainty
Working Paper, EUI MWP, 2009/31
KRIWOLUZKY, Alexander, STOLTENBERG, Christian A., Nested Models and Model Uncertainty, EUI MWP, 2009/31 - http://hdl.handle.net/1814/12521
Retrieved from Cadmus, EUI Research Repository
Uncertainty about the appropriate choice among nested models is a central concern for optimal policy when policy prescriptions from those models differ. The standard procedure is to specify a prior over the parameter space ignoring the special status of some sub-models, e.g. those resulting from zero restrictions. This is especially problematic if a model's generalization could be either true progress or the latest fad found to fit the data. We propose a procedure that ensures that the specified set of submodels is not discarded too easily and thus receives no weight in determining optimal policy. We find that optimal policy based on our procedure leads to substantial welfare gains compared to the standard practice.
Cadmus permanent link: http://hdl.handle.net/1814/12521
Series/Number: EUI MWP; 2009/31