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Optimal Investment and Equilibrium Pricing under Ambiguity

Author

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  • Michail Anthropelos

    (University of Piraeus - Department of Banking and Financial Management)

  • Paul Schneider

    (University of Lugano - Institute of Finance; Swiss Finance Institute)

Abstract

We consider portfolio selection under nonparametric alpha-maxmin ambiguity in the neighbourhood of a reference distribution. We show strict concavity of the portfolio problem under ambiguity aversion.Implied demand functions are nondifferentiable, resemble observed bid-ask spreads, and are consistent with existing parametric limiting participation results under ambiguity. Ambiguity seekers exhibit a discontinuous demand function, implying an empty set of reservation prices. If agents have identical, or sufficiently similar prior beliefs, the first best equilibrium is no trade. Simple sufficient conditions yield the existence of a Pareto-efficient second-best equilibrium which reconciles many observed phenomena in financial markets, such as liquidity dry-ups, portfolio inertia, and negative risk premia.

Suggested Citation

  • Michail Anthropelos & Paul Schneider, 2021. "Optimal Investment and Equilibrium Pricing under Ambiguity," Swiss Finance Institute Research Paper Series 21-78, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2178
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    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
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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