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Ambiguity and Reality

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  • Trojani, Fabio

    ()

  • Wiehenkamp, Christian

    ()

  • Wrampelmeyer, Jan

    ()

Abstract

Model builders face ambiguity about the true data generating process. Consequently, they need to deal with ambiguity attitudes (inside uncertainty) and ambiguous financial reality (outside uncertainty) when developing and estimating financial models. We introduce a novel approach for systematically dealing with outside uncertainty in addition to inside uncertainty in a tractable way. By bounding the effects of ambiguous data features, we avoid the adverse consequences of outside uncertainty, such as strongly biased equity premiums and investment policies. In a real data application, we show that asset managers can be more reliably evaluated using our bounded-influence approach.

Suggested Citation

  • Trojani, Fabio & Wiehenkamp, Christian & Wrampelmeyer, Jan, 2014. "Ambiguity and Reality," Working Papers on Finance 1418, University of St. Gallen, School of Finance.
  • Handle: RePEc:usg:sfwpfi:2014:18
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    File URL: http://ux-tauri.unisg.ch/RePEc/usg/sfwpfi/WPF-1418.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Knightian Uncertainty; Model Risk; Ambiguity Aversion; Robust Econometrics; Portfolio Choice; Option Pricing;

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • 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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