Ambiguity and Asset Markets

Larry Epstein and Martin Schneider

Annual Review of Financial Economics, 2010, vol. 2, issue 1, 315-346

Abstract: The Ellsberg paradox suggests that people's behavior is different in risky situations—when they are given objective probabilities—from their behavior in ambiguous situations—when they are not told the odds (as is typical in financial markets). Such behavior is inconsistent with subjective expected utility (SEU) theory, the standard model of choice under uncertainty in financial economics. This article reviews models of ambiguity aversion. It shows that such models—in particular, the multiple-priors model of Gilboa and Schmeidler—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.

Keywords: portfolio choice; asset pricing (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (187)

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