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Optimal portfolio under ambiguous ambiguity

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

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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.

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