Separating the Effects of Beliefs and Attitudes on Pricing under Ambiguity

48 Pages Posted: 10 Mar 2021

See all articles by Wenhui Li

Wenhui Li

SAFE Goethe University Frankfurt

Christian Wilde

Goethe University Frankfurt - Department of Finance

Date Written: February 28, 2021

Abstract

The pricing of an ambiguous asset, whose cash flow stream is uncertain, may be affected by three factors: the belief regarding the realization likelihood of cash flows, the subjective attitude towards risk, and the attitude towards ambiguity. While previous literature looks at the total price discount under ambiguity, this paper investigates with laboratory experiments how much effect each factor can induce. We apply both non-parametric and parametric methods to cleanly separate the belief effects, the risk premiums, and the ambiguity premiums from each other. Both methods lead to similar results: Overall, subjects have substantial ambiguity aversion, and ambiguity premiums account for the largest price deviation component when the degree of ambiguity is high. As information accumulates, ambiguity premiums decrease. We also find that beliefs do influence prices under ambiguity. This is not because beliefs are biased towards either good or bad scenarios per se, but because subjects display sticky belief updating as new information becomes available. The clear separation performed in this paper between belief and attitude also enables a more accurate estimation of the parameter of ambiguity aversion compared to previous studies, since the effect of beliefs is partialled out. Overall, we find empirically that both factors, belief and attitude towards ambiguity, are important factors in pricing under ambiguity.

Keywords: ambiguity, belief estimation, belief effect, ambiguity premium, laboratory experiments

JEL Classification: D81, D83

Suggested Citation

Li, Wenhui and Wilde, Christian, Separating the Effects of Beliefs and Attitudes on Pricing under Ambiguity (February 28, 2021). SAFE Working Paper No. 311, Available at SSRN: https://ssrn.com/abstract=3801713 or http://dx.doi.org/10.2139/ssrn.3801713

Wenhui Li

SAFE Goethe University Frankfurt ( email )

Gr├╝neburgplatz 1
Frankfurt
Germany

Christian Wilde (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Grueneburgplatz 1
Frankfurt am Main, Hessen 60323
Germany

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