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Ambiguity arbitrage

Author

Listed:
  • Saeed Badri

    (VU - Vrije Universiteit Amsterdam [Amsterdam])

  • Aurélien Baillon

    (EM - EMLyon Business School, GATE Lyon Saint-Étienne - Groupe d'Analyse et de Théorie Economique Lyon - Saint-Etienne - UL2 - Université Lumière - Lyon 2 - UJM - Université Jean Monnet - Saint-Étienne - UJM EPE - Université Jean Monnet (EPSCPE) - EM - EMLyon Business School - CNRS - Centre National de la Recherche Scientifique)

  • Bertrand Tavin

    (EM - EMLyon Business School, GATE Lyon Saint-Étienne - Groupe d'Analyse et de Théorie Economique Lyon - Saint-Etienne - UL2 - Université Lumière - Lyon 2 - UJM - Université Jean Monnet - Saint-Étienne - UJM EPE - Université Jean Monnet (EPSCPE) - EM - EMLyon Business School - CNRS - Centre National de la Recherche Scientifique)

Abstract

Standard asset pricing models assume common risk preferences across markets. However, market segmentation and market-specific ambiguity may undermine this assumption. We develop a behavioral model combining narrow bracketing with source theory, allowing for differential responses to ambiguity across markets. The model predicts systematic cross-market valuation discrepancies, which can be exploited through what we call ambiguity arbitrage: a strategy that buys and sells probabilistically equivalent digital options across markets to exploit differences in ambiguity attitudes, and that can be made asymptotically riskless. Estimating the model for the U.S. stock market, crude oil, and the euro-dollar exchange rate, we obtain the first market-based estimates of comparative ambiguity attitudes across markets and document substantial source dependence. The resulting price gaps are too large to be risk premia. Ambiguity arbitrage would have generated large cumulative profits over 2008–2025.

Suggested Citation

  • Saeed Badri & Aurélien Baillon & Bertrand Tavin, 2026. "Ambiguity arbitrage," Working Papers hal-05726650, HAL.
    • Handle: RePEc:hal:wpaper:hal-05726650
    Note: View the original document on HAL open archive server: https://hal.science/hal-05726650v2
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