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Ambiguity Aversion and Under-diversification

53 Pages Posted: 25 Jan 2014 Last revised: 27 Aug 2014

Massimo Guidolin

Bocconi University - Department of Finance

Hening Liu

University of Manchester

Date Written: March 1, 2014


We examine asset allocation decisions under smooth ambiguity aversion when an investor has a prior degree of belief in an asset pricing model (e.g., the domestic CAPM). Different from a Bayesian approach, the investor separately relies on the conditional distribution of returns and on the posterior over parameters to make decisions, rather than on the predictive distribution of returns that integrates priors and likelihood information. We find that in the perspective of US investors, ambiguity aversion generates strong home bias in equity holdings, regardless of beliefs in the CAPM or risk aversion. Results become stronger under regime-switching investment opportunities.

Keywords: Ambiguity aversion, Bayesian portfolio analysis, CAPM, Smooth ambiguity

JEL Classification: C61, D81, G11

Suggested Citation

Guidolin, Massimo and Liu, Hening, Ambiguity Aversion and Under-diversification (March 1, 2014). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: or

Massimo Guidolin

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136

Hening Liu (Contact Author)

University of Manchester ( email )

Crawford House
Booth Street West
Manchester, M15 6PB
United Kingdom


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