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Ambiguity aversion for risk choice

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  • Wang, Yuli
  • Niu, Yingjie

Abstract

This paper extends the model of the portfolio choice of hedge fund managers compensated by high-water mark contracts by incorporating three types of ambiguity aversion. Each setting is motivated by a different robust control optimization problem. The first setting illustrates that optimal portfolios are negatively affected by ambiguity aversion parameter as well as the volatility of risky assets. On the contrary, the second (κ-ignorance) and third methodology (constrained ambiguity) outline distinctive results. Under these two settings, the manager allocates more wealth to risky assets on the condition that ambiguity aversion rises. As for regular risk measured by volatility, we show that the critical value of investment strategy exhibits a U-shaped pattern against the volatility of risky assets. This is due to the game between risk attitude and market price of risk in effect.

Suggested Citation

  • Wang, Yuli & Niu, Yingjie, 2020. "Ambiguity aversion for risk choice," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    • Handle: RePEc:eee:ecofin:v:54:y:2020:i:c:s1062940820301509
    DOI: 10.1016/j.najef.2020.101253
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    More about this item

    Keywords

    Ambiguity aversion; Risk; High-water mark; Portfolio choice;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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