Optimal portfolio under ambiguous ambiguity

17 Pages Posted: 5 Feb 2020 Last revised: 14 Feb 2021

See all articles by Dmitry Makarov

Dmitry Makarov

HSE University, International College of Economics and Finance (ICEF)

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

Makarov, Dmitry, Optimal portfolio under ambiguous ambiguity (January 8, 2021). Finance Research Letters, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3526898 or http://dx.doi.org/10.2139/ssrn.3526898

Dmitry Makarov (Contact Author)

HSE University, International College of Economics and Finance (ICEF) ( email )

26 Shabolovka
Moscow
Russia

HOME PAGE: http://www.nes.ru/~dmakarov

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