Fuzzy measures and asset prices: accounting for information ambiguity
AbstractA recent stream of literature has suggested that many market imperfections or 'puzzles' can be easily explained once information ambiguity, or knightian uncertainty is taken into account. Here we propose a parametric representation of this concept by means of a special class of fuzzy measures, known as gλ-measures. The parameter λ may be considered an indicator of uncertainty. Starting with a distribution, a value λ in (0, ∞) and a benchmark utility function we obtain a sub-additive expected utility, representing uncertainty aversion. A dual value λ* in (-1, 0) defining a super-additive expected utility is also recovered, while the benchmark expected utility is obtained for λ = λ* = 0. The two measures may be considered as lower and upper bounds of expected utility with respect to a set of probability measures, in the spirit of Gilboa-Schmeidler MMEU theory and of Dempster probability interval approach. The parametrization may be used to determine the effect of information ambiguity on asset prices in a very straightforward way. As examples, we determine the price of a corporate debt contract and a 'fuzzified' version of the Black and Scholes model.
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Bibliographic InfoArticle provided by Taylor and Francis Journals in its journal Applied Mathematical Finance.
Volume (Year): 4 (1997)
Issue (Month): 3 ()
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