Knightian Uncertainty, k-Ignorance, and Optimal Timing
AbstractWe investigate within a continuous time setting how Knightian uncertainty characterized by k-ignorance affects the optimal timing policies of a risk-neutral and uncertainty averse investor in the case where the exercise payoff is monotonic. We prove that increased Knightian uncertainty unambiguously decreases the value of the optimal timing policy of an uncertainty averse investor. We also show that higher Knightian uncertainty accelerates timing by shrinking the continuation region whenever the termination payoff is independent of Knightian uncertainty. If this independence condition is not fulfilled, then our results indicate that higher Knightian uncertainty may decelerate optimal timing.
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Bibliographic InfoPaper provided by Aboa Centre for Economics in its series Discussion Papers with number 25.
Date of creation: Nov 2007
Date of revision:
Knightian uncertainty; k-ambiguity; optimal stopping; diffusions;
Find related papers by JEL classification:
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D92 - Microeconomics - - Intertemporal Choice - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
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- Larry G. Epstein & Martin Schneider, 2001.
RCER Working Papers
485, University of Rochester - Center for Economic Research (RCER).
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