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- Title
First-Order Certainty Equivalence with Instrument-Dependent Randomness.
- Authors
Laffont, Jean-jacques
- Abstract
This article examines first-order certainty equivalence with instrument-dependent randomness. The classical decision problem in which a decision maker has to choose values of some instruments or control variables in such a way as to maximize a payoff function which involves instruments as well as non-controlled variables related to the instruments through a model has been examined. The decision models have been characterized which allow the great mathematical simplification of certainty equivalence or first-order certainty equivalence. When stochastic elements enter the payoff function or the model, we obtain the optimal solution through maximization of the expected payoff function. It has been held that certainty equivalence holds when the optimal solution is identical to the solution obtained through a maximization where all stochastic variables have been replaced by their expected values. Introducing a distance function to vary degrees of uncertainty, the first-order certainty equivalence holds if the discrepancy between the optimal solution and the certainty equivalent is of order greater than one in the uncertainty distance, in the neighbourhood of the certain problem.
- Subjects
CERTAINTY; ECONOMIC equilibrium; DECISION making; LINEAR systems; PROBABILITY theory; STATISTICS; STOCHASTIC processes; MATHEMATICAL optimization; EXPECTED returns; ECONOMICS
- Publication
Review of Economic Studies, 1975, Vol 42, Issue 4, p605
- ISSN
0034-6527
- Publication type
Article
- DOI
10.2307/2296797