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Ambiguity aversion and trade

Luciano De Castro and Alain Chateauneuf ()
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Luciano De Castro: Kellogg School of Management - Northwestern University (Evanston)

Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) from HAL

Abstract: What is the effect of ambiguity aversion on trade? Although in a Bewley's model, ambiguity aversion always leads to less trade; in other models, this is not always true. However, we show that if the endowments are unambiguous, then more ambiguity aversion implies less trade for a very general class of preferences. The reduction in trade caused by ambiguity aversion can be as severe as to lead to no trade. In an economy with MEU decision makers, we show that if the aggregate endowment is unanimously unambiguous, then every Pareto optima allocation is also unambiguous. We also characterize the situation in which every unanimously unambiguous allocation is Pareto optimal. Finally, we show how our results can be used to explain the home-bias effect. As a useful result for our methods, we also obtain an additivity theorem for CEU and MEU decision makers that does not require comonotonicity.

Keywords: Ambiguity aversion; Pareto optimality (search for similar items in EconPapers)
Date: 2011-10
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Published in Economic Theory, Springer Verlag, 2011, 48 (2/3), pp.243-273. ⟨10.1007/s00199-011-0642-6⟩

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DOI: 10.1007/s00199-011-0642-6

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