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Investment Behavior under Ambiguity: The Case of Pessimistic Decision Makers

  • Ludwig, Alexander

    ()

    (Mannheim Research Institute for the Economics of Aging (MEA) and Sonderforschungsbereich 504)

  • Zimper, Alexander

    ()

    (Sonderforschungsbereich 504)

We define pessimistic, respectively optimistic, investors as CEU (Choquet expected utility) decision makers who update their pessimistic, respectively optimistic, beliefs according to a pessimistic (Dempster-Shafer), respectively optimistic, update rule. This paper then demonstrates that, in contrast to optimistic investors, pessimistic investors may strictly prefer investing in an illiquid asset to investing in a liquid asset. Key to our result is the dynamic inconsistency of CEU decision making, implying that a CEU decision maker ex ante prefers a different strategy with respect to prematurely liquidating an uncertain long-term investment project than after learning her liquidity needs. Investing in an illiquid asset then serves as a commitment device guaranteeing an ex ante favorable outcome.

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Paper provided by Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim in its series Sonderforschungsbereich 504 Publications with number 04-31.

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Length: 19 pages
Date of creation: 13 Sep 2004
Date of revision:
Handle: RePEc:xrs:sfbmaa:04-31
Note: We thank Jürgen Eichberger, Itzhak Gilboa, and Nicolas Nalpas for helpful suggestions. Moreover, we appreciate the feedback from participants at FUR XI, Paris. Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim and from the Gesamtverband der Deutschen Versicherungswirtschaft is gratefully acknowledged.
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