Risk versus Ambiguity and International Security Design

Brian Hill () and Tomasz Michalski

No 1032, HEC Research Papers Series from HEC Paris

Abstract: This paper studies portfolio allocation in the international financial market when investors exhibit ambiguity aversion towards assets issued in foreign locations. Entrepreneurs located in each country have access to a risky technology and want to attract capital. The authors characterize contracts issued by firms in such an environment. Increases in the variance of the risky production process causes firms to increase the variable payment (equity) offered to investors. On the other hand, increases in investor ambiguity lead to less risk-sharing. Entrepreneurs located in countries with low levels of domestic wealth issue assets with a higher fixed payment and a lower risky payment. As a result, they are exposed to higher volatility per unit of consumption as they finance themselves relatively more through debt than equity. An increase in ambiguity or ambiguity aversion that characterizes crises may explain flight of capital to capital-abundant countries – dubbed sometimes as “flight to quality”.

Keywords: ambiguity aversion; risk aversion; debt/equity choice; international capital flows; international insurance; home bias (search for similar items in EconPapers)
JEL-codes: D81 F21 F34 G11 G15 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2014-02-21
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Risk versus ambiguity and international security design (2018)
Working Paper: Risk versus ambiguity and international security design (2018)
Working Paper: Risk Versus Ambiguity and International Security Design (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ebg:heccah:1032

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