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Optimal portfolio under ambiguous ambiguity

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  • Makarov, Dmitry

Abstract

A prominent approach to modelling ambiguity about stock return distribution is to assume that investors have multiple priors about the distribution and these priors are distributed according to a certain second-order distribution. Realistically, investors may also have multiple priors about the second-order distribution, thus allowing for ambiguous ambiguity. Despite a long history of debates about this idea (Reichenbach [1949], Savage [1954]), there seems to be no formal analysis of investment behavior in the presence of this feature. We develop a tractable portfolio choice framework incorporating ambiguous ambiguity, characterize analytically the optimal portfolio, and examine its properties.

Suggested Citation

  • Makarov, Dmitry, 2020. "Optimal portfolio under ambiguous ambiguity," MPRA Paper 108837, University Library of Munich, Germany, revised Dec 2020.
    • Handle: RePEc:pra:mprapa:108837
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    References listed on IDEAS

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    More about this item

    Keywords

    ambiguous ambiguity; portfolio choice; smooth ambiguity; third-order probabilities;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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