Ambiguity in asset pricing and portfolio choice: a review of the literature

Massimo Guidolin and Francesca Rinaldi

No 2010-028, Working Papers from Federal Reserve Bank of St. Louis

Abstract: A growing body of empirical evidence suggests that investors? behavior is not well described by the traditional paradigm of (subjective) expected utility maximization under rational expectations. A literature has arisen that models agents whose choices are consistent with models that are less restrictive than the standard subjective expected utility framework. In this paper we conduct a survey of the existing literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. We conclude that the ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions, such as the empirical failure of the two-fund separation theorem in portfolio decisions, the modest exposure to risky securities observed for a majority of investors, the home equity preference in international portfolio diversification, the excess volatility of asset returns, the equity premium and the risk-free rate puzzles, and the occurrence of trading break-downs.

Keywords: capital asset pricing model; Investments (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-cba and nep-upt
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Citations: View citations in EconPapers (16)

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Related works:
Journal Article: Ambiguity in asset pricing and portfolio choice: a review of the literature (2013)
Working Paper: Ambiguity in Asset Pricing and Portfolio Choice: A Review of the Literature (2011)
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DOI: 10.20955/wp.2010.028

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