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Does Ambiguity Generate Demand for Options?

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  • Takashi Nishiwaki

    (Graduate School of Economics,Waseda University. 1-6-1, Nishi-Waseda, Shinjukuku, Tokyo 169-8050, Japan.)

Abstract

This study examines the optimal investment strategies for risk-and-ambiguityaverse investors and characterizes conditions under which ambiguity induces investors to buy or sell options. Under identical hyperbolic absolute risk aversion (HARA) utility functions, we illustrate that ambiguity-averse investors should sell portfolio insurance if their preferences exhibit constant relative risk aversion (CRRA). In particular, when investors’ relative risk aversion is less than or equal to two, ambiguity-averse investors should sell options at any realization values of a reference asset. Further, if the relative risk aversion is greater than two, we demonstrate that ambiguity-averse investors should sell and buy options at smaller and higher realization values of the reference asset, respectively. Furthermore, if the utility functions display constant absolute risk aversion (CARA), then an ambiguity-averse investor should buy options at any realization values of the reference asset.

Suggested Citation

  • Takashi Nishiwaki, 2021. "Does Ambiguity Generate Demand for Options?," Working Papers 2102, Waseda University, Faculty of Political Science and Economics.
    • Handle: RePEc:wap:wpaper:2102
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    More about this item

    Keywords

    Ambiguity; Multiple prior model; Options demand; Kullback– Leibler divergence;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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