Does Ambiguity Generate Demand for Options?

Takashi Nishiwaki ()

No 2102, Working Papers from Waseda University, Faculty of Political Science and Economics

Abstract: This study examines the optimal investment strategies for risk-and-ambiguityaverse investors and characterizes conditions under which ambiguity induces investors to buy or sell options. Under identical hyperbolic absolute risk aversion (HARA) utility functions, we illustrate that ambiguity-averse investors should sell portfolio insurance if their preferences exhibit constant relative risk aversion (CRRA). In particular, when investors’ relative risk aversion is less than or equal to two, ambiguity-averse investors should sell options at any realization values of a reference asset. Further, if the relative risk aversion is greater than two, we demonstrate that ambiguity-averse investors should sell and buy options at smaller and higher realization values of the reference asset, respectively. Furthermore, if the utility functions display constant absolute risk aversion (CARA), then an ambiguity-averse investor should buy options at any realization values of the reference asset.

Keywords: Ambiguity; Multiple prior model; Options demand; Kullback– Leibler divergence (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2021-04
New Economics Papers: this item is included in nep-ias, nep-mic, nep-ore and nep-upt
References: View references in EconPapers View complete reference list from CitEc
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Related works:
Working Paper: Does Ambiguity Generate Demand for Options? (2020)
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