Limit Orders under Knightian Uncertainty

Abstract

Investors who maximize subjective expected utility will generally trade in an asset unless the market price exactly equals the expected return, but few people participate in the stock market. [Dow and da Costa Werlang, Econometrica 1992] show that an ambiguity averse decision maker might abstain from trading in an asset for a wide interval of prices and use this fact to explain the lack of participation in the stock market. We show that when markets operate via limit orders, all investment behavior will be observationally equivalent to maximizing subjective expected utility; ambiguity aversion has no additional explanatory power. * Examples similar to our motivating example have been studied by Dominique Päper and Peter Habiger in their respective master theses written under the supervision of Christoph Kuzmics. We are grateful to both as well as Patrick Beissner, Frank Riedel, Jan Werner, and Michael Zierhut as well as seminar audiences at the

Market Allocations under Ambiguity: A Survey

“…Recently, Greinecker and Kuzmics (2019) showed that, if agents have to take decision in the form of limit orders (i.e., deciding on how much to invest contingent on the realized price of the asset), then ambiguity aversion does not produce results that can be distinguished from standard expected utility maximization. The result rests on the observation that ambiguity averse agents have a preference for randomization (built in the convex CEU and MEU criterion)…”