Journal Article

Portfolio Choices and Asset Prices: The Comparative Statics of Ambiguity Aversion

Christian Gollier

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 78, issue 4, pages 1329-1344
Published in print October 2011 | ISSN: 0034-6527
Published online May 2011 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1093/restud/rdr013
Portfolio Choices and Asset Prices: The Comparative Statics of Ambiguity Aversion

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This paper investigates the comparative statics of “more ambiguity aversion” as defined by Klibanoff, Marinacci and Mukerji (2005, “A Smooth Model of Decision Making under Ambiguity”, Econometrica, 73 (6), 1849–1892). The analysis uses the static two-asset portfolio problem with one safe asset and one uncertain one. While it is intuitive that more ambiguity aversion would reduce demand for the uncertain asset, this is not necessarily the case. We derive sufficient conditions for a reduction in the demand for the uncertain asset and for an increase in the equity premium. An example that meets the sufficient conditions is when the set of plausible distributions for returns on the uncertain asset can be ranked according to their monotone likelihood ratio. It is also shown how ambiguity aversion distorts the price kernel in the alternative portfolio problem with complete markets for contingent claims.

Keywords: Smooth ambiguity aversion; Monotone likelihood ratio; Equity premium; Portfolio choice; Price kernel; Central dominance; D81

Journal Article.  7292 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy

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