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Knightian Uncertainty in Financial Markets: An Assessment

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  • Marcello Basili

Abstract

type="main" xml:lang="en"> If information is too vague and imprecise to be summarized by a unique additive probability measure, an agent faces Knightian uncertainty or ambiguity rather than risk. Under Knightian uncertainty, an agent's beliefs may be represented by a capacity or a set of additive probabilities. It is proved that an agent's attitude towards ambiguity has a crucial role in asset price determination and portfolio choice. Knightian uncertainty attitude provides an alternative explanation of financial market failures and enables puzzles to be solved, such as market breakdowns, price indeterminacy and volatility, bid and ask spreads, portfolio inertia, violation of call and put parity. (J.E.L.: D81, G11, G12).

Suggested Citation

  • Marcello Basili, 2001. "Knightian Uncertainty in Financial Markets: An Assessment," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 30(1), pages 1-26, February.
    • Handle: RePEc:bla:ecnote:v:30:y:2001:i:1:p:1-26
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    File URL: http://hdl.handle.net/10.1111/1468-0300.00045
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    Cited by:

    1. Marcello Basili & Carlo Zappia, 2009. "Shackle And Modern Decision Theory," Metroeconomica, Wiley Blackwell, vol. 60(2), pages 245-282, May.
    2. Dirk G. Baur & Thomas K.J. McDermott, 2011. "Safe Haven Assets and Investor Behaviour Under Uncertainty," The Institute for International Integration Studies Discussion Paper Series iiisdp392, IIIS, revised Feb 2012.

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