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Survival with ambiguity

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  • Guerdjikova, Ani
  • Sciubba, Emanuela

Abstract

We analyze a market populated by expected utility maximizers and smooth ambiguity-averse consumers. We study conditions under which ambiguity-averse consumers survive and affect prices in the limit. If ambiguity vanishes with time or if the economy exhibits no aggregate risk, ambiguity-averse consumers survive, but have no long-run impact on prices. In both scenarios ambiguity-averse consumers are fully insured against ambiguity in equilibrium and thus behave as expected utility maximizers with correct beliefs. If ambiguity-averse consumers are not fully insured against ambiguity, their behavior mimics expected utility maximizers with wrong beliefs and a stochastic discount factor which might be consistently higher or lower than their actual discount factor. We use this insight to analyze a Markov economy with large persistent ambiguity. Consumers with decreasing absolute ambiguity aversion whose prudence with respect to ambiguity exceeds twice their absolute ambiguity aversion a.s. survive in the presence of expected utility maximizers with correct beliefs. If the economy further exhibits aggregate risk, they drive the expected utility maximizers out of the market and determine prices in the limit. In contrast, consumers with increasing or constant absolute ambiguity aversion only survive in the absence of aggregate risk and have no impact on limit prices.

Suggested Citation

  • Guerdjikova, Ani & Sciubba, Emanuela, 2015. "Survival with ambiguity," Journal of Economic Theory, Elsevier, vol. 155(C), pages 50-94.
  • Handle: RePEc:eee:jetheo:v:155:y:2015:i:c:p:50-94
    DOI: 10.1016/j.jet.2014.11.006
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    Cited by:

    1. Timothy Cogley & Thomas J. Sargent & Viktor Tsyrennikov, 2014. "Wealth Dynamics in a Bond Economy with Heterogeneous Beliefs," Economic Journal, Royal Economic Society, vol. 124(575), pages 1-30, March.
    2. Anwar, Sajid & Zheng, Mingli, 2012. "Competitive insurance market in the presence of ambiguity," Insurance: Mathematics and Economics, Elsevier, vol. 50(1), pages 79-84.
    3. Pietro Dindo & Filippo Massari, 2017. "The Wisdom of the Crowd in Dynamic Economies," Working Papers 2017:17, Department of Economics, University of Venice "Ca' Foscari".
    4. Simon Quemin, 2016. "Intertemporal abatement decisions under ambiguity aversion in a cap and trade," Working Papers 1604, Chaire Economie du climat.
    5. Pietro Dindo, 2015. "Survival in Speculative Markets," LEM Papers Series 2015/32, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    6. repec:spr:joecth:v:66:y:2018:i:2:d:10.1007_s00199-017-1066-8 is not listed on IDEAS
    7. repec:kap:expeco:v:21:y:2018:i:2:d:10.1007_s10683-017-9542-3 is not listed on IDEAS
    8. Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2015. "Long-run Heterogeneity in an Exchange Economy with Fixed-Mix Traders," LEM Papers Series 2015/29, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    9. Massimo Marinacci, 2015. "Model Uncertainty," Journal of the European Economic Association, European Economic Association, vol. 13(6), pages 1022-1100, December.
    10. Araujo, Aloisio & da Silva, Pietro & Faro, José Heleno, 2016. "Ambiguity aversion in the long run: “To disagree, we must also agree”," Journal of Economic Theory, Elsevier, vol. 165(C), pages 242-256.
    11. Loic Berger & Valentina Bosetti, 2016. "Ellsberg re-revisited: An experiment disentangling model uncertainty and risk aversion," Working Papers 576, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    12. Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2018. "Momentum and Reversal in Financial Markets with Persistent Heterogeneity," LEM Papers Series 2018/04, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    13. repec:eee:eecrev:v:103:y:2018:i:c:p:108-124 is not listed on IDEAS

    More about this item

    Keywords

    Ambiguity; Ambiguity-aversion; Survival;

    JEL classification:

    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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