Modeling Ambiguity and Risk in Inflation Expectations: Empirical Analysis for Brazil.

For developing economies, agents' disagreement (risk) about future inflation can be tricky, mostly when the range of possibilities is not clear (ambiguity). We use the Brazilian survey of inflation forecasts to model ambiguity and risk in inflation expectations, considering 1, 6, and 12 months ahead. Our results indicate that an ambiguity inflation expectations shock (6 and 12 months time window) can negatively affect Brazilian economic cycles. On the other hand, risk shocks seem to have a moderate and significant effect only for 1 month ahead of expectations. This evidence shows that the maintenance of short and medium-run monetary policies, such as forward guidance, may depend on dynamics that go beyond first-order volatility. [ABSTRACT FROM AUTHOR]