Optimal Investment and Equilibrium Pricing under Ambiguity

55 Pages Posted: 24 Nov 2021 Last revised: 19 Apr 2024

See all articles by Michail Anthropelos

Michail Anthropelos

University of Piraeus - Department of Banking and Financial Management

Paul Schneider

University of Lugano - Institute of Finance; Swiss Finance Institute

Date Written: November 24, 2021

Abstract

We consider portfolio selection under nonparametric alpha-maxmin ambiguity in the neighbourhood of a reference distribution. We show strict concavity of the portfolio problem under ambiguity aversion.Implied demand functions are nondifferentiable, resemble observed bid-ask spreads, and are consistent with existing parametric limiting participation results under ambiguity. Ambiguity seekers exhibit a discontinuous demand function, implying an empty set of reservation prices. If agents have identical, or sufficiently similar prior beliefs, the first best equilibrium is no trade. Simple sufficient conditions yield the existence of a Pareto-efficient second-best equilibrium which reconciles many observed phenomena in financial markets, such as liquidity dry-ups, portfolio inertia, and negative risk premia.

Keywords: ambiguity, equilibrium, asset pricing

JEL Classification: G11, G12, G41, C62, D84

Suggested Citation

Anthropelos, Michail and Schneider, Paul Georg, Optimal Investment and Equilibrium Pricing under Ambiguity (November 24, 2021). Swiss Finance Institute Research Paper No. 21-78, Available at SSRN: https://ssrn.com/abstract=3970575 or http://dx.doi.org/10.2139/ssrn.3970575

Michail Anthropelos

University of Piraeus - Department of Banking and Financial Management ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece

Paul Georg Schneider (Contact Author)

University of Lugano - Institute of Finance ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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