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Learning Under Ambiguity

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
Contact details of provider: Postal: University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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  1. Epstein, Larry G. & Miao, Jianjun, 2003. "A two-person dynamic equilibrium under ambiguity," Journal of Economic Dynamics and Control, Elsevier, vol. 27(7), pages 1253-1288, May.
  2. Bryan Routledge & Stanley Zin, . "Model Uncertainty and Liquidity," GSIA Working Papers 2001-E17, Carnegie Mellon University, Tepper School of Business.
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  4. L.C.G. Rogers, 2001. "The relaxed investor and parameter uncertainty," Finance and Stochastics, Springer, vol. 5(2), pages 131-154.
  5. Kjetil Storesletten & Chris Telmer & Amir Yaron, . "Asset pricing with idiosyncratic risk and overlapping generations," GSIA Working Papers 226, Carnegie Mellon University, Tepper School of Business.
  6. Marco Cagetti & Lars Peter Hansen & Thomas Sargent & Noah Williams, 2002. "Robustness and Pricing with Uncertain Growth," Review of Financial Studies, Society for Financial Studies, vol. 15(2), pages 363-404, March.
  7. Harrison Hong & Jeremy C. Stein, 2003. "Differences of Opinion, Short-Sales Constraints, and Market Crashes," Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 487-525.
  8. Haliassos, Michalis & Michaelides, Alexander, 2001. "Portfolio Choice and Liquidity Constraints," CEPR Discussion Papers 2822, C.E.P.R. Discussion Papers.
  9. Larry G. Epstein & Martin Schneider, 2001. "Recursive Multiple-Priors," RCER Working Papers 485, University of Rochester - Center for Economic Research (RCER).
  10. Lars Hansen & Thomas Sargent & Thomas Tallarini, . "Robust Permanent Income and Pricing," GSIA Working Papers 1997-51, Carnegie Mellon University, Tepper School of Business.
  11. Gennotte, Gerard, 1986. " Optimal Portfolio Choice under Incomplete Information," Journal of Finance, American Finance Association, vol. 41(3), pages 733-46, July.
  12. Epstein, Larry G. & Schneider, Martin, 2003. "IID: independently and indistinguishably distributed," Journal of Economic Theory, Elsevier, vol. 113(1), pages 32-50, November.
  13. Kandel, Shmuel & Stambaugh, Robert F, 1996. " On the Predictability of Stock Returns: An Asset-Allocation Perspective," Journal of Finance, American Finance Association, vol. 51(2), pages 385-424, June.
  14. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  15. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March.
  16. Luigi Guiso & Tullio Jappelli, 2000. "Household Portfolios in Italy," CSEF Working Papers 43, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  17. Massimo Marinacci, 2002. "Learning from ambiguous urns," Statistical Papers, Springer, vol. 43(1), pages 143-151, January.
  18. Detemple, Jerome B, 1986. " Asset Pricing in a Production Economy with Incomplete Information," Journal of Finance, American Finance Association, vol. 41(2), pages 383-91, June.
  19. Sujoy Mukerji & Jean-Marc Tallon, 2002. "Ellsberg`s 2-Color Experiment, Bid-Ask Behavior and Ambiguity," Economics Series Working Papers 114, University of Oxford, Department of Economics.
  20. Zengjing Chen & Larry Epstein, 2002. "Ambiguity, Risk, and Asset Returns in Continuous Time," Econometrica, Econometric Society, vol. 70(4), pages 1403-1443, July.
  21. Pascal J. Maenhout, 2004. "Robust Portfolio Rules and Asset Pricing," Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 951-983.
  22. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  23. Andrew B. Abel, 2001. "An exploration of the effects of pessimism and doubt on asset returns," Working Papers 01-1, Federal Reserve Bank of Philadelphia.
  24. Ang, Andrew & Bekaert, Geert & Liu, Jun, 2005. "Why stocks may disappoint," Journal of Financial Economics, Elsevier, vol. 76(3), pages 471-508, June.
  25. Carsten Krabbe Nielsen, 1995. "Rational Belief Structures and Rational Belief Equilibrium," Discussion Papers 95-14, University of Copenhagen. Department of Economics.
  26. Timmermann, Allan G, 1993. "How Learning in Financial Markets Generates Excess Volatility and Predictability in Stock Prices," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1135-45, November.
  27. Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1137-1187.
  28. Hansen, Lars Peter & Sargent, Thomas J. & Wang, Neng E., 2002. "Robust Permanent Income And Pricing With Filtering," Macroeconomic Dynamics, Cambridge University Press, vol. 6(01), pages 40-84, February.
  29. Marinacci, Massimo, 1999. "Limit Laws for Non-additive Probabilities and Their Frequentist Interpretation," Journal of Economic Theory, Elsevier, vol. 84(2), pages 145-195, February.
  30. Peter Bossaerts, 2000. "Learning-Induced Securities Price Volatility," Computing in Economics and Finance 2000 299, Society for Computational Economics.
  31. Alon Brav & J.B. Heaton, 2002. "Competing Theories of Financial Anomalies," Review of Financial Studies, Society for Financial Studies, vol. 15(2), pages 575-606, March.
  32. Larry Epstein & Martin Schneider, 2004. "Ambiguity, Information Quality and Asset Pricing," RCER Working Papers 507, University of Rochester - Center for Economic Research (RCER).
  33. Veldkamp, Laura L., 2005. "Slow boom, sudden crash," Journal of Economic Theory, Elsevier, vol. 124(2), pages 230-257, October.
  34. Brennan, Michael J. & Xia, Yihong, 2001. "Stock price volatility and equity premium," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 249-283, April.
  35. Truman F. Bewley, 1988. "Knightian Decision Theory and Econometric Inference," Cowles Foundation Discussion Papers 868, Cowles Foundation for Research in Economics, Yale University.
  36. Jonathan Lewellen & Jay Shanken, 2002. "Learning, Asset-Pricing Tests, and Market Efficiency," Journal of Finance, American Finance Association, vol. 57(3), pages 1113-1145, 06.
  37. repec:cup:macdyn:v:6:y:2002:i:1:p:40-84 is not listed on IDEAS
  38. 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.
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