Ambiguity in Asset Markets: Theory and Experiment
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This article studied the impact of ambiguity and ambiguity aversion on equilibrium asset prices and portfolio holdings in competitive financial markets, and found that attitudes toward ambiguity are heterogeneous across the population, just as attitudes toward risk are heterogeneities across the populations, but that heterogeneity of attitudes towards ambiguity has different implications than heterogeneity of attitude toward risk, and that investors who are sufficiently ambiguity averse find open sets of prices for which they refuse to hold an ambiguous portfolio.Abstract:
This paper studies the impact of ambiguity and ambiguity aversion on equilibrium asset prices and portfolio holdings in competitive financial markets. It argues that attitudes toward ambiguity are heterogeneous across the population, just as attitudes toward risk are heterogeneous across the population, but that heterogeneity of attitudes toward ambiguity has different implications than heterogeneity of attitudes toward risk. In particular, when some state probabilities are not known, agents who are sufficiently ambiguity averse find open sets of prices for which they refuse to hold an ambiguous portfolio. This suggests a different cross section of portfolio choices, a wider range of state price/probability ratios, and different rankings of state price/probability ratios than would be predicted if state probabilities were known. Experiments confirm all of these suggestions. Our findings contradict the claim that investors who have cognitive biases do not affect prices because they are inframarginal: ambiguity-averse investors have an indirect effect on prices because they change the per capita amount of risk that is to be shared among the marginal investors. Our experimental data also suggest a positive correlation between risk aversion and ambiguity aversion that might explain the "value effect" in historical data. (JEL G11, G12, C92, D53)read more
Citations
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Neural Representation of Subjective Value Under Risk and Ambiguity
Ifat Levy,Jason Snell,Amy J. Nelson,Amy J. Nelson,Aldo Rustichini,Paul W. Glimcher,Paul W. Glimcher +6 more
TL;DR: A common system, consisting of at least the striatum and the medial prefrontal cortex, was found to represent subjective value under both conditions, and this work concluded that risk aversion and ambiguity aversion are distinct phenomena.
Journal ArticleDOI
Ambiguity and Asset Markets
TL;DR: In this article, the authors review models of ambiguity aversion and show that such models have implications for portfolio choice and asset pricing that are very different from those of SEU and that help to explain otherwise puzzling features of the data.
Journal ArticleDOI
Decision theory under ambiguity
TL;DR: In this article, the authors present a review of recent advances in the field of decision making under uncertainty or ambiguity, and present a general approach to a decision problem under uncertainty, as well as the'standard' Bayesian treatment and issues with this treatment.
Journal ArticleDOI
Individual Irrationality and Aggregate Outcomes
Ernst Fehr,Jean-Robert Tyran +1 more
TL;DR: In this article, the authors discuss evidence indicating that strategic complementarity and strategic substitutability are decisive determinants of aggregate outcomes, and that a small amount of individual irrationality may lead to large deviations from the aggregate predictions of rational models.
Journal ArticleDOI
Estimating Ambiguity Aversion in a Portfolio Choice Experiment
TL;DR: The authors employ graphical representations of three-dimensional budget sets over bundles of Arrow securities, one of which promises a unit payoff with a known probability and two with unknown (ambiguous) probabilities.
References
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Journal ArticleDOI
The Cross‐Section of Expected Stock Returns
Eugene F. Fama,Kenneth R. French +1 more
TL;DR: In this paper, Bhandari et al. found that the relationship between market/3 and average return is flat, even when 3 is the only explanatory variable, and when the tests allow for variation in 3 that is unrelated to size.
Book
Risk, Uncertainty and Profit
TL;DR: In Risk, Uncertainty and Profit, Frank Knight explored the riddle of profitability in a competitive market profit should not be possible under competitive conditions, as the entry of new entrepreneurs would drive prices down and nullify margins, however evidence abounds of competitive yet profitable markets as mentioned in this paper.
Journal ArticleDOI
Risk, Ambiguity, and the Savage Axioms
TL;DR: The notion of "degrees of belief" was introduced by Knight as mentioned in this paper, who argued that people tend to behave "as though" they assigned numerical probabilities to events, or degrees of belief to the events impinging on their actions.
Journal ArticleDOI
MAxmin expected utility with non-unique prior
TL;DR: In this paper, the authors characterize preference relations over acts which have a numerical representation by the functional J(f) = min > {∫ uo f dP / P∈C } where f is an act, u is a von Neumann-Morgenstern utility over outcomes, and C is a closed and convex set of finitely additive probability measures on the states of nature.