Ambiguity, Infra-Marginal Investors, and Market Prices
It is difficult to explain the price insensitive or infra-marginal behavior, an example of which is the behavior of credit markets during the recent financial crisis, by risk aversion alone. It is known that infra-marginal behavior may arise with ambiguity aversion. Furthermore, there appears to be fairly strong evidence of a close connection between ambiguity and conformity. Here we propose an extension of the standard ambiguity framework to incorporate conformity. We find that there are open sets of state-price ratios over which the entire market is price insensitive or infra-marginal. This result has important implications for market equilibrium and volatility
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- Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March.
- Fabio Trojani & Markus Leippold & Paolo Vanini, 2005.
"Learning and Asset Prices under Ambiguous Information,"
University of St. Gallen Department of Economics working paper series 2005
2005-03, Department of Economics, University of St. Gallen.
- Markus Leippold & Fabio Trojani & Paolo Vanini, 2008. "Learning and Asset Prices Under Ambiguous Information," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2565-2597, November.
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