Caution under Ambiguity and Blowups

Abstract

We develop an axiomatically consistent way of ranking and scoring actively managed funds and investment strategies. Our performance measure accounts for the feature that investors may exhibit caution, via the mechanism of ambiguity aversion, when evaluating investment strategies. Linking developed theory to data, we feature evidence on a real-world question: Do investors gain by selling the tails of return distributions? Using data on options on (i) the S&P 500 equity index, and (ii) Treasury bond futures, our answer to this question is in the negative. We complement our evidence from options on STOXX 50, FTSE, and Nikkei equity indexes.

Keywords: ambiguity, tail risk

JEL Classification: G11, G12