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A Smooth Ambiguity Model Of The Competitive Firm

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  • Kit Pong Wong

Abstract

type="main"> This paper examines the optimal production decision of the competitive firm under price uncertainty when the firm's preferences exhibit smooth ambiguity aversion. Ambiguity is modeled by a second-order probability distribution that captures the firm's uncertainty about which of the subjective beliefs govern the price risk. Ambiguity preferences are modeled by the (second-order) expectation of a concave transformation of the (first-order) expected utility of profit conditional on each plausible subjective distribution of the price risk. Within this framework, we derive necessary and sufficient conditions under which the ambiguity-averse firm optimally produces less in response either to the introduction of ambiguity or to greater ambiguity aversion when ambiguity prevails. In the case that the price risk is binary, we show that ambiguity and greater ambiguity aversion always adversely affect the firm's production decision.

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  • Kit Pong Wong, 2015. "A Smooth Ambiguity Model Of The Competitive Firm," Bulletin of Economic Research, Wiley Blackwell, vol. 67(S1), pages 97-110, December.
    • Handle: RePEc:bla:buecrs:v:67:y:2015:i:s1:p:s97-s110
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    References listed on IDEAS

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    Cited by:

    1. Simon Quemin, 2016. "Intertemporal abatement decisions under ambiguity aversion in a cap and trade," Working Papers 1604, Chaire Economie du climat.
    2. Takashi Nishiwaki, 2020. "Does Ambiguity Generate Demand for Options?," Working Papers 2011, Waseda University, Faculty of Political Science and Economics.
    3. Gong, Di & Jiang, Tao & Li, Zhao & Wu, Weixing, 2022. "Optimal loan contracting under policy uncertainty: Theory and international evidence," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 77(C).
    4. Udo Broll & Peter Welzel & Kit Pong Wong, 2018. "Ambiguity preferences, risk taking and the banking firm," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 8(3), pages 343-353, December.
    5. Broll, Udo & Welzel, Peter & Wong, Kit Pong, 2016. "The banking firm under ambiguity aversion," CEPIE Working Papers 01/16, Technische Universität Dresden, Center of Public and International Economics (CEPIE).
    6. Broll, Udo & Wong, Kit Pong, 2015. "The incentive to trade under ambiguity aversion," The Journal of Economic Asymmetries, Elsevier, vol. 12(2), pages 190-196.

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