Does Uncertainty Vanish in the Small? The Smooth Ambiguity Case

Massimo Marinacci, Doriana Ruffino and Fabio Maccheroni
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Fabio Maccheroni: Bocconi University

No 619, 2011 Meeting Papers from Society for Economic Dynamics

Abstract: We study orders of risk and model uncertainty aversion in the smooth ambiguity model proposed by Klibanoff, Marinacci, and Mukerji (2005). We consider a quadratic approximation of their model and we show that both risk and model uncertainty attitudes have at most a second order effect. Specifically, the order depends on the properties of the support of the decision maker's limit prior, which we fully characterize. We find that model uncertainty attitudes have a second order effect unless the support is a singleton, that is, unless model uncertainty fades away in the limit. Specializing our general analysis to the case of a binomial state space allows relating the results to important applications in stochastic calculus and mathematical finance.

Date: 2011
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Working Paper: Does Uncertainty Vanish in the Small? The Smooth Ambiguity Case (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed011:619

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