On Ambiguity-Seeking Behavior in Finance Models with Smooth Ambiguity

58 Pages Posted: 5 Dec 2019 Last revised: 4 Jan 2021

See all articles by Dmitry Makarov

Dmitry Makarov

HSE University, International College of Economics and Finance (ICEF)

Date Written: Januart 3, 2021

Abstract

Ambiguity-seeking behavior is universally disregarded in a large theoretical finance literature with smooth ambiguity preferences. This paper questions the three rationales for this practice. First, smooth ambiguity models are not ill-defined under ambiguity-seeking. Second, a representative investor need not be ambiguity-averse when an average individual trader is ambiguity-averse. Third, individual traders need not be ambiguity-averse when a representative investor is ambiguity-averse. Our constructive suggestion is that researchers should calculate the allowed levels of ambiguity-seeking for which their model is wellposed, and then let the data speak for themselves whether ambiguity-seeking or ambiguity-aversion can better explain empirical evidence.

Keywords: ambiguity-loving, smooth ambiguity, investor heterogeneity, representative investor, limited participation

JEL Classification: D81, G12, G11

Suggested Citation

Makarov, Dmitry, On Ambiguity-Seeking Behavior in Finance Models with Smooth Ambiguity (Januart 3, 2021). Proceedings of Paris December 2020 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3493649 or http://dx.doi.org/10.2139/ssrn.3493649

Dmitry Makarov (Contact Author)

HSE University, International College of Economics and Finance (ICEF) ( email )

26 Shabolovka
Moscow
Russia

HOME PAGE: http://www.nes.ru/~dmakarov

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