Ambiguity in Asset Markets: Theory and Experiment

Peter Bossaerts, Paolo Ghirardato, Serena Guarnaschelli and William Zame

No 27, Carlo Alberto Notebooks from Collegio Carlo Alberto

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 infra-marginal: 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.

Keywords: Ambiguity; Experiments; Financial Markets; Heterogeneity (search for similar items in EconPapers)
JEL-codes: C91 D53 D81 G11 G12 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2006, Revised 2009
New Economics Papers: this item is included in nep-exp, nep-fin, nep-fmk and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Journal Article: Ambiguity in Asset Markets: Theory and Experiment (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:cca:wpaper:27

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