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Consumption of Durable Goods under Ambiguity

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  • Othón M. Moreno

Abstract

The focus of this paper is to analyze the effect that ambiguity will have on the buyer's reservation price and the value of the option to purchase the durable good with an embedded option to resell it. The agent is assumed to be risk neutral and ambiguity averse. The problem is formulated as an optimal stopping problem with multiple priors in continuous time with infinite horizon. Uncertainty comes from prices, which is summarized in a state variable that follows a Brownian motion. Preferences have a multiple-prior utility representation where the set of priors consist of a family of Brownian motions with unknown drift and common variance. We show that the direction of the change in the buyer's reservation price depends on the parametrization of the model and that the value of the embedded option is decreasing in the perceived level of ambiguity.

Suggested Citation

  • Othón M. Moreno, 2014. "Consumption of Durable Goods under Ambiguity," Working Papers 2014-02, Banco de México.
  • Handle: RePEc:bdm:wpaper:2014-02
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    File URL: http://www.banxico.org.mx/publicaciones-y-discursos/publicaciones/documentos-de-investigacion/banxico/%7BEB36FFDE-2247-1A79-83BE-C6B9037343EF%7D.pdf
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    References listed on IDEAS

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    5. Klibanoff, Peter & Marinacci, Massimo & Mukerji, Sujoy, 2009. "Recursive smooth ambiguity preferences," Journal of Economic Theory, Elsevier, vol. 144(3), pages 930-976, May.
    6. Epstein, Larry G. & Schneider, Martin, 2003. "Recursive multiple-priors," Journal of Economic Theory, Elsevier, vol. 113(1), pages 1-31, November.
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    More about this item

    Keywords

    Ambiguity; optimal stopping; embedded option; durable goods;

    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
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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