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Investment Behavior under Ambiguity: The Case of Pessimistic Decision Makers

  • Alexander Ludwig

    ()

  • Alexander Zimper

    (Munich Center for the Economics of Aging (MEA))

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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Paper provided by Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy in its series MEA discussion paper series with number 04060.

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Date of creation: 10 Nov 2004
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Handle: RePEc:mea:meawpa:04060
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