Ambiguity and Reality

61 Pages Posted: 30 Aug 2010 Last revised: 27 Jan 2015

See all articles by Fabio Trojani

Fabio Trojani

Swiss Finance Institute; University of Geneva

Christian Wiehenkamp

affiliation not provided to SSRN

Jan Wrampelmeyer

Vrije Universiteit Amsterdam, School of Business and Economics; Tinbergen Institute

Date Written: December 4, 2014

Abstract

Model builders face ambiguity about the true data generating process. Consequently, they need to deal with ambiguity attitudes (inside uncertainty) and ambiguous financial reality (outside uncertainty) when developing and estimating financial models. We introduce a novel approach for systematically dealing with outside uncertainty in addition to inside uncertainty in a tractable way. By bounding the effects of ambiguous data features, we avoid the adverse consequences of outside uncertainty, such as strongly biased equity premiums and investment policies. In a real data application, we show that asset managers can be more reliably evaluated using our bounded-influence approach.

The internet appendix for this paper is available at the following URL: http://ssrn.com/abstract=2218212

Keywords: Knightian Uncertainty, Model Risk, Ambiguity Aversion, Robust Econometrics, Portfolio Choice, Option Pricing

JEL Classification: C13, C15, D81, G11, G12

Suggested Citation

Trojani, Fabio and Wiehenkamp, Christian and Wrampelmeyer, Jan, Ambiguity and Reality (December 4, 2014). Swiss Finance Institute Research Paper No. 11-33; University of St.Gallen, School of Finance Research Paper No. 2014/18. Available at SSRN: https://ssrn.com/abstract=1668569 or http://dx.doi.org/10.2139/ssrn.1668569

Fabio Trojani

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

University of Geneva ( email )

Geneva
Switzerland

Christian Wiehenkamp

affiliation not provided to SSRN

Jan Wrampelmeyer (Contact Author)

Vrije Universiteit Amsterdam, School of Business and Economics ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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