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Ambiguity and Asset Markets

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  • Larry G. Epstein
  • Martin Schneider

Abstract

The Ellsberg paradox suggests that people behave differently in risky situations -- when they are given objective probabilities -- than in ambiguous situations when they are not told the odds (as is typical in financial markets). Such behavior is inconsistent with subjective expected utility theory (SEU), the standard model of choice under uncertainty in financial economics. This article reviews models of ambiguity aversion. It shows that such models -- in particular, the multiple-priors model of Gilboa and Schmeidler -- have implications for portfolio choice and asset pricing that are very different from those of SEU and that help to explain otherwise puzzling features of the data.

Suggested Citation

  • Larry G. Epstein & Martin Schneider, 2010. "Ambiguity and Asset Markets," NBER Working Papers 16181, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:16181
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    More about this item

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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