Ambiguity Sensitive Preferences in Ellsberg Frameworks

Abstract

We study the market implications of ambiguity sensitive preferences using the alpha-maxmin expected utility (alpha-MEU) model. 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, alpha-MEU, maxmin, maxmax and SEU models induce different portfolio choices. We suggest criteria to discriminate among these models in laboratory experiments and show that ambiguity seeking 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