Ambiguity and Asset Markets

52 Pages Posted: 12 Jul 2010 Last revised: 19 Sep 2010

See all articles by Larry G. Epstein

Larry G. Epstein

University of Rochester - Department of Economics

Martin Schneider

Stanford University

Date Written: July 2010

Abstract

The Ellsberg paradox suggests that people behave differently in risky situations -- when they are given objective probabilities -- than in ambiguous situations when they are not told the odds (as is typical in financial markets). Such behavior is inconsistent with subjective expected utility theory (SEU), the standard model of choice under uncertainty in financial economics. This article reviews models of ambiguity aversion. It shows that such models -- in particular, the multiple-priors model of Gilboa and Schmeidler -- have implications for portfolio choice and asset pricing that are very different from those of SEU and that help to explain otherwise puzzling features of the data.

Suggested Citation

Epstein, Larry and Schneider, Martin, Ambiguity and Asset Markets (July 2010). NBER Working Paper No. w16181. Available at SSRN: https://ssrn.com/abstract=1636650

Larry Epstein (Contact Author)

University of Rochester - Department of Economics ( email )

Harkness Hall
Rochester, NY 14627-0158
United States
585-275-4320 (Phone)

Martin Schneider

Stanford University ( email )

Stanford, CA 94305
United States

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