Model Uncertainty and Liquidity

Bryan Routledge () and Stanley Zin

No 1617, Econometric Society World Congress 2000 Contributed Papers from Econometric Society

Abstract: We investigate the dynamic portfolio problem of a market-maker for a derivative security whose preferences exhibit uncertainty aversion (Knightian uncertainty). The Choquet-expected utility implied by such preference is used to capture the feature that the trader is uncertain about which model should be used. The prices that emerge from the model are similar to standard models and have the feature that as uncertainty is removed, the derivative prices converge to standard prices. However, the optimal changes in the agent's portfolio that results from the option position are quite different than the standard hedge position. It is this feature that links uncertainty with market liquidity.

Date: 2000-08-01
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Model Uncertainty and Liquidity (2009)
Working Paper: Model Uncertainty and Liquidity (2001)
Working Paper: MODEL UNCERTAINITY AND LIQUIDITY (2000)
Working Paper: Model Uncertainty and Liquidity
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