Learning about investment risk: The effects of structural uncertainty on dynamic investment and consumption

We analyze a general equilibrium model where production shocks are unobservable and there is structural uncertainty regarding investment risk because the volatility of the production shocks is unknown. Higher investment generally accelerates learning on the unknown parameter, but the dynamic interaction between learning and investment is complex. We quantify this interaction by numerically computing equilibrium investment and consumption in a version of the model calibrated by aggregate US data. We find that imperfect observability (of productivity shocks) by itself does not significantly affect equilibrium investment and consumption, but structural uncertainty significantly impacts equilibrium investment and consumption levels.