This paper introduces the Knightian Uncertainty Hypothesis (KUH), a new approach to macroeconomics and finance theory.
This paper introduces the Knightian Uncertainty Hypothesis (KUH), a new approach to macroeconomics and finance theory. KUH rests on a novel mathematical framework that characterizes both measurable and Knightian uncertainty about economic outcomes. Relying on this framework and John Muth鈥檚 pathbreaking hypothesis, KUH represents participants鈥� forecasts to be consistent with both uncertainties. KUH thus enables models of aggregate outcomes that 1) are premised on market participants鈥� rationality, and 2) yet accord a role to both fundamental and psychological (and other non-fundamental) factors in driving outcomes. The paper also suggests how a KUH model鈥檚 quantitative predictions can be confronted with time-series data.