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The identification of attitudes towards ambiguity and risk from asset demand

Herakles Polemarchakis, Larry Selden and Xinxi Song
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Herakles Polemarchakis: Department of Economics, University of Warwick and LabEx MME-DII, University of Paris 2
Larry Selden: Columbia Business School, Columbia University and University of Pennsylvania
Xinxi Song: International School of Economics and Management, Capital University of Economics and Business

CRETA Online Discussion Paper Series from Centre for Research in Economic Theory and its Applications CRETA

Abstract: Individuals behave differently when they know the objective probability of events and when they do not. The smooth ambiguity model accommodates both ambiguity (uncertainty) and risk. For an incomplete, competitive asset market, we develop a revealed preference test for asset demand to be consistent with the maximization of smooth ambiguity preferences ; and we show that ambiguity preferences constructed from finite observations converge to underlying ambiguity preferences as observations become dense. Subsequently, we give sufficient conditions for the asset demand generated by smooth ambiguity preferences to identify the ambiguity and risk indices as well as the ambiguity probability measure. We do not require ambiguity beliefs to be observable : in a generalized specification, they may not even be defined. An ambiguity free asset plays an important role for identification.

Keywords: risk; uncertainty; identification JEL classification numbers: D11; D80; D81 (search for similar items in EconPapers)
Date: 2017
New Economics Papers: this item is included in nep-mic, nep-rmg and nep-upt
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