Ambiguity in Asset Markets: Theory and Experiment

Abstract

This paper studies the impact of ambiguity and ambiguity aversion on equilibrium asset prices and portfolio holdings in competitive financial markets. It argues that attitudes toward ambiguity are heterogeneous across the population, just as attitudes toward risk are heterogeneous across the population, but that heterogeneity of attitudes toward ambiguity has different implications than heterogeneity of attitudes toward risk. In particular, when some state probabilities are not known, agents who are sufficiently ambiguity averse find open sets of prices for which they refuse to hold an ambiguous portfolio. This suggests a different cross-section of portfolio choices, a wider range of state price/probability ratios and different rankings of state price/probability ratios than would be predicted if state probabilities were known. Experiments confirm all of these suggestions. Our findings contradict the claim that investors who have cognitive biases do not affect prices because they are infra-marginal: ambiguity averse investors have an indirect effect on prices because they change the per-capita amount of risk that is to be shared among the marginal investors. Our experimental data also suggest a positive correlation between risk aversion and ambiguity aversion that might explain the "value effect" in historical data. JEL Classification: C91, D53, D81, G11, G12

Reference Dependent Ambiguity Aversion: Theory and Experiment

“…We then computed the nonparametric Spearman correlation of the risk aversion and ambiguity aversion and found a statistically significant positive correlation of 0.49 (p < 0.01). This result is consistent with the study of Bossaerts et al (2010), where the authors suggest that a positive riskambiguity correlation may be able to explain the 'value effect' in historical financial market data.…”

Adverse Selection vs Discrimination Risk with Genetic Testing: An Experimental Approach

“…However, in our experimental sample the correlation between these variables is 0.189, with a p-value of 0.095. This moderate but significant correlation is consistent with the literature in neuroscience and economics (Hsu et al, 2005;Bossaerts et al, 2010;Potamites and Zhang, 2012).…”

Do Ambiguity Effects Survive in Experimental Asset Markets?

“…For example, even if the transaction prices for R and A are equal, it is possible that the bids for R are all fairly close to the clearing price (indicating relatively homogenous risk preferences), while higher heterogeneity in ambiguity preferences creates an order book for A where bids deviate more strongly downwards. This notion is in line with Bossaerts et al (2010), who report a high heterogeneity in traders`ambiguity preferences. To test possible ambiguity eects on order books we compute the median bid dierence and the median ask dierence between R and A in CM.…”

“…By contrast, we used strong ambiguity and study its eects in the gain domain. Bossaerts et al (2010) used a double auction environment to experimentally investigate the simultaneous trading of assets with state-dependent dividends where state probabilities were either risky or ambiguous. They administered a three-color Ellsberg urn, where the payos from the risky and the ambiguous asset are not independent from each other, and they let subjects learn about the composition of the ambiguous urn by drawing balls without replacement.…”