Conservative Holdings, Aggressive Trades: Ambiguity, Learning, and Equilibrium Flows

Abstract

We study equilibrium asset prices and portfolio flows in a model where agents learn about economic fundamentals and differ in their aversion to parameter uncertainty. Exploiting the connection between confidence intervals from classical statistics and multi-prior sets for ambiguity-sensitive decision makers, we show that, because ambiguity-averse agents hold conservative portfolios, in equilibrium they have more risk-bearing capacity, making them natural buyers of risky assets when volatility rises. The model generates time-varying risk premia that are amplified by bad news and dampened by good news. We provide empirical support of our model predictions using a novel dataset of trading activity on Euro Stoxx 50 futures contracts.

Keywords: Ambiguity, uncertainty, learning, portfolio flows, equilibrium asset prices, heterogeneous agents

JEL Classification: G11, G12