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Ambiguity Aversion and Trade

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  • Alain Chateauneuf
  • Luciano I. de Castro

Abstract

What is the effect of ambiguity aversion on trade? Although in a Bewley's model ambiguity aversion always lead to less trade, in other models this is not always true. However, we show that if the endowments are unambiguous then more ambiguity aversion implies less trade, for a very general class of preferences. The reduction in trade caused by ambiguity aversion can be as severe as to lead to no-trade. In an economy with MEU decision makers, we show that if the aggregate endowment is unanimously unambiguous then every Pareto optima allocation is also unambiguous. We also characterize the situation in which every unanimously unambiguous allocation is Pareto optimal. Finally, we show how our results can be used to explain the home-bias effect. As a useful result for our methods, we also obtain an additivity theorem for CEU and MEU decision makers that does not require comonotonicity. JEL Classification Numbers: D51, D6, D8

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Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1526.

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Date of creation: 01 Apr 2011
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Handle: RePEc:nwu:cmsems:1526

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Citations

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Cited by:
  1. Faro, José Heleno, 2012. "Cobb-Douglas Preferences under Uncertainty," Insper Working Papers wpe_278, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
  2. Lombardi Michele & Yoshihara Naoki, 2010. "A Full Characterization of Nash Implementation with Strategy Space Reduction," Research Memorandum 023, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  3. Tatjana Chudjakow & Frank Riedel, 2013. "The best choice problem under ambiguity," Economic Theory, Springer, vol. 54(1), pages 77-97, September.
  4. M. Peiris & Alexandros Vardoulakis, 2013. "Savings and default," Economic Theory, Springer, vol. 54(1), pages 153-180, September.
  5. Patrick Beißner, 2013. "Radner equilibria under ambiguous volatility," Working Papers 493, Bielefeld University, Center for Mathematical Economics.
  6. Tamini, Lota Dabio, 2012. "Optimal quality choice under uncertainty on market development," Working Papers 148589, Structure and Performance of Agriculture and Agri-products Industry (SPAA).
  7. Tamini, Lota D., 2012. "Optimal quality choice under uncertainty on market development," MPRA Paper 40845, University Library of Munich, Germany.

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