Optimal portfolio under ambiguous ambiguity

Makarov, Dmitry (2020): Optimal portfolio under ambiguous ambiguity. Forthcoming in: Finance Research Letters

Abstract

A prominent approach to modelling ambiguity about stock return distribution is to assume that investors have multiple priors about the distribution and these priors are distributed according to a certain second-order distribution. Realistically, investors may also have multiple priors about the second-order distribution, thus allowing for ambiguous ambiguity. Despite a long history of debates about this idea (Reichenbach [1949], Savage [1954]), there seems to be no formal analysis of investment behavior in the presence of this feature. We develop a tractable portfolio choice framework incorporating ambiguous ambiguity, characterize analytically the optimal portfolio, and examine its properties.

• Item Type: MPRA Paper
• Language: English
• Keywords: ambiguous ambiguity, portfolio choice, smooth ambiguity, third-order probabilities
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions

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