Ambiguity Aversion in Ellsberg Frameworks

Abstract

We study optimal portfolio choice and equilibrium asset prices induced by alpha-maxmin expected utility (alpha-MEU) models. In the standard Ellsberg framework we prove that alpha-MEU preferences are equivalent to either maxmin, maxmax or subjective expected utility (SEU). We show how ambiguity aversion impacts equilibrium asset prices, and revisit the laboratory experimental findings in Bossaerts, Ghirardato, Guarnaschelli, and Zame (2010). Only when there are three or more ambiguous states the alpha-MEU, maxmin, maxmax and SEU models induce different portfolio choices. We suggest criteria to discriminate among these models in laboratory experiments. Finally, we find that ambiguity seeking alpha-MEU agents may prevent the existence of market equilibrium. Our results indicate that ambiguity matters for portfolio choice and does not wash out in equilibrium.

Keywords: Ellsberg framework, alpha-maxmin expected utility model, ambiguity aversion, portfolio choice, market equilibrium

JEL Classification: G11, G12, C92, D53