Ambiguity and Reality

Fabio Trojani (), Christian Wiehenkamp () and Jan Wrampelmeyer

No 1418, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: Model builders face ambiguity about the true data generating process. Consequently, they need to deal with ambiguity attitudes (inside uncertainty) and ambiguous financial reality (outside uncertainty) when developing and estimating financial models. We introduce a novel approach for systematically dealing with outside uncertainty in addition to inside uncertainty in a tractable way. By bounding the effects of ambiguous data features, we avoid the adverse consequences of outside uncertainty, such as strongly biased equity premiums and investment policies. In a real data application, we show that asset managers can be more reliably evaluated using our bounded-influence approach.

Keywords: Knightian Uncertainty; Model Risk; Ambiguity Aversion; Robust Econometrics; Portfolio Choice; Option Pricing (search for similar items in EconPapers)
JEL-codes: C13 C15 D81 G11 G12 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2014-12
New Economics Papers: this item is included in nep-ore and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:usg:sfwpfi:2014:18

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