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Learning Under Ambiguity

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This paper considers learning when the distinction between risk and ambiguity (Knightian uncertainty) matters. Working within the framework of recursive multiple-priors utility, the paper formulates a counterpart of the Bayesian model of learning about an uncertain parameter from conditionally i.i.d. signals. Ambiguous signals capture responses to information that cannot be captured by noisy signals. They induce nonmonotonic changes in agent confidence and prevent ambiguity from vanishing in the limit. In a dynamic portfolio choice model, learning about ambiguous returns leads to endogenous stock market participation costs that depend on past market performance. Hedging of ambiguity provides a new reason why the investment horizon matters for portfolio choice.

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File URL: http://rcer.econ.rochester.edu/RCERPAPERS/rcer_497.pdf
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Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number 497.

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Length: 36 pages
Date of creation: Oct 2002
Date of revision: Mar 2005
Handle: RePEc:roc:rocher:497
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University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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  5. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March.
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  8. Kjetil Storesletten & Chris Telmer & Amir Yaron, 1996. "Asset pricing with idiosyncratic risk and overlapping generations," Economics Working Papers 405, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 1999.
  9. Pascal J. Maenhout, 2004. "Robust Portfolio Rules and Asset Pricing," Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 951-983.
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  13. Lars Hansen & Thomas Sargent & Thomas Tallarini, "undated". "Robust Permanent Income and Pricing," GSIA Working Papers 1997-51, Carnegie Mellon University, Tepper School of Business.
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  15. Allan G. Timmermann, 1993. "How Learning in Financial Markets Generates Excess Volatility and Predictability in Stock Prices," The Quarterly Journal of Economics, Oxford University Press, vol. 108(4), pages 1135-1145.
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  21. Abel, Andrew B., 2002. "An exploration of the effects of pessimism and doubt on asset returns," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1075-1092, July.
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  23. Michael Haliassos & Alexander Michaelides, 2003. "Portfolio Choice and Liquidity Constraints," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 143-177, February.
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  25. Carsten Krabbe Nielsen, 1995. "Rational Belief Structures and Rational Belief Equilibrium," Discussion Papers 95-14, University of Copenhagen. Department of Economics.
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  28. Larry Epstein & Martin Schneider, 2002. "IID: Independently and Indistinguishably Distributed," RCER Working Papers 496, University of Rochester - Center for Economic Research (RCER).
  29. Detemple, Jerome B, 1986. " Asset Pricing in a Production Economy with Incomplete Information," Journal of Finance, American Finance Association, vol. 41(2), pages 383-391, June.
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  34. repec:cup:macdyn:v:6:y:2002:i:1:p:40-84 is not listed on IDEAS
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  39. Nicholas Barberis, 2000. "Investing for the Long Run when Returns Are Predictable," Journal of Finance, American Finance Association, vol. 55(1), pages 225-264, 02.
  40. M. J. Brennan, 1998. "The Role of Learning in Dynamic Portfolio Decisions," Review of Finance, European Finance Association, vol. 1(3), pages 295-306.
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