Investor Behavior Under Epistemic versus Aleatory Uncertainty

Abstract

We provide evidence that investor behavior is sensitive to two dimensions of subjective uncertainty concerning future asset values. Investors vary in the extent to which they attribute market uncertainty to: (1) missing knowledge, skill, or information (epistemic uncertainty), and (2) chance or stochastic processes (aleatory uncertainty). Investors who view stock market uncertainty as higher in epistemicness (knowability) are more likely to reduce uncertainty by seeking guidance from experts and are more responsive to available information when choosing whether or not to invest. In contrast, investors who view stock market uncertainty as higher in aleatoriness (randomness) are more likely to reduce uncertainty through diversification and their risk preferences better predict whether or not they choose to invest. We show, further, that attributions of uncertainty can be perturbed by the format in which historical information is presented: charts displaying absolute stock prices promote perceptions of epistemicness and greater willingness to pay for financial advice, whereas charts displaying the change in stock prices from one period to the next promote perceptions of aleatoriness and a greater tendency to diversify.

Keywords: Investor Behavior, Financial Decision Making, Uncertainty, Epistemic, Aleatory