Limit Orders and Knightian Uncertainty
25 Pages Posted: 7 Apr 2020 Last revised: 1 Jun 2020
Date Written: May 11, 2020
Ambiguity averse decision-makers can behave in financial portfolio problems in ways that cannot be rationalized as subjective expected utility maximization. Indeed, [Dow and da Costa Werlang, Econometrica 1992] show that an ambiguity-averse decision-maker might abstain from trading an asset for a wide interval of prices; something no subjective expected utility maximizer can. Dow and da Costa Werlang assume that decision-makers know the price of an asset when trading. We show that when markets operate via limit orders instead, all investment behavior of an ambiguity-averse decision-maker is observationally equivalent to the behavior of a subjective expected utility maximizer with the same risk preferences; ambiguity aversion has no additional explanatory power.
Keywords: Knightian uncertainty, ambiguity aversion, subjective expected utility, financial market participation, strict dominance
JEL Classification: D81, G11, C72
Suggested Citation: Suggested Citation