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Investment behavior under ambiguity: The case of pessimistic decision makers

  • Ludwig, Alexander
  • Zimper, Alexander

We define pessimistic, respectively optimistic, investors as CEU (Choquet expected utility) decision makers who update their pessimistic, respectively optimistic, beliefs according to a pessimistic (Dempster-Shafer), respectively optimistic, update rule. This paper then demonstrates that, in contrast to optimistic investors, pessimistic investors may strictly prefer investing in an illiquid asset to investing in a liquid asset. Key to our result is the dynamic inconsistency of CEU decision making, implying that a CEU decision maker ex ante prefers a different strategy with respect to prematurely liquidating an uncertain long-term investment project than after learning her liquidity needs. Investing in an illiquid asset then serves as a commitment device guaranteeing an ex ante favorable outcome.

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Article provided by Elsevier in its journal Mathematical Social Sciences.

Volume (Year): 52 (2006)
Issue (Month): 2 (September)
Pages: 111-130

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Handle: RePEc:eee:matsoc:v:52:y:2006:i:2:p:111-130
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