Optimal portfolio under ambiguous ambiguity
17 Pages Posted: 5 Feb 2020 Last revised: 14 Feb 2021
Date Written: January 8, 2021
Abstract
A prominent approach to modelling ambiguity about stock return distribution is to assume that investors have multiple priors about the distribution and these priors are distributed according to a certain second-order distribution. Realistically, investors may also have multiple priors about the second-order distribution, thus allowing for ambiguous ambiguity. Despite a long history of debates about this idea (Reichenbach [1949], Savage [1954]), there seems to be no formal analysis of investment behavior in the presence of this feature. We develop a tractable portfolio choice framework incorporating ambiguous ambiguity, characterize analytically the optimal portfolio,
and examine its properties.
Keywords: ambiguous ambiguity, portfolio choice, smooth ambiguity, third-order probabilities
JEL Classification: D81, G11, G41
Suggested Citation: Suggested Citation