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Learning Under Ambiguity

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Author Info
Larry Epstein () (University of Rochester)
Martin Schneider () (New York University)

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Abstract

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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Publisher Info
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.

For technical questions regarding this item, or to correct its listing, contact: (Terry Fisher).

Related research
Keywords: ambiguity learning noisy signals ambiguous signals quality information portfolio choice portfolio diversification Ellsberg Paradox

Other versions of this item:

Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
D9 - Microeconomics - - Intertemporal Choice and Growth
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Bryan R. Routledge & Stanley E. Zin, 2001. "Model Uncertainty and Liquidity," NBER Working Papers 8683, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. 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. [Downloadable!]
  3. Larry G. Epstein & JianJun Miao, 2001. "A Two-Person Dynamic Equilibrium under Ambiguity," RCER Working Papers 478, University of Rochester - Center for Economic Research (RCER). [Downloadable!]
    Other versions:
  4. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March. [Downloadable!] (restricted)
  5. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April. [Downloadable!] (restricted)
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    Other versions:
  7. Gennotte, Gerard, 1986. " Optimal Portfolio Choice under Incomplete Information," Journal of Finance, American Finance Association, vol. 41(3), pages 733-46, July. [Downloadable!] (restricted)
  8. Brennan, Michael J. & Xia, Yihong, 2001. "Stock price volatility and equity premium," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 249-283, April. [Downloadable!] (restricted)
  9. Larry Epstein & Martin Schneider, 2002. "IID: Independently and Indistinguishably Distributed," RCER Working Papers 496, University of Rochester - Center for Economic Research (RCER). [Downloadable!]
    Other versions:
  10. Truman F. Bewley, 1988. "Knightian Decision Theory and Econometric Inference," Cowles Foundation Discussion Papers 868, Cowles Foundation, Yale University. [Downloadable!]
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  13. Brandt, M.W.Michael W. & Zeng, Qi & Zhang, Lu, 2004. "Equilibrium stock return dynamics under alternative rules of learning about hidden states," Journal of Economic Dynamics and Control, Elsevier, vol. 28(10), pages 1925-1954, September. [Downloadable!] (restricted)
    Other versions:
  14. 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. [Downloadable!] (restricted)
  15. Larry Epstein & Martin Schneider, 2005. "Ambiguity, Information Quality and Asset Pricing," RCER Working Papers 519, University of Rochester - Center for Economic Research (RCER). [Downloadable!]
    Other versions:
  16. 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. [Downloadable!] (restricted)
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  20. 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.
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  22. 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. [Downloadable!] (restricted)
  23. Michael Haliassos, Alexander Michaelides, 2000. "Portfolio Choice And Liquidity Constraints," Computing in Economics and Finance 2000 297, Society for Computational Economics. [Downloadable!]
    Other versions:
  24. repec:cup:macdyn:v:6:y:2002:i:1:p:40-84 is not listed on IDEAS
  25. Alon Brav & J.B. Heaton, 2002. "Competing Theories of Financial Anomalies," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(2), pages 575-606, March.
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  27. Storesletten, Kjetil & Telmer, Chris & Yaron, Amir, 2001. "Asset Pricing with Idiosyncratic Risk and Overlapping Generations," CEPR Discussion Papers 3065, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  28. Marco Cagetti & Lars Peter Hansen & Thomas Sargent & Noah Williams, 2002. "Robustness and Pricing with Uncertain Growth," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(2), pages 363-404, March.
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  31. 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. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. ALLARD, Marie & BRONSARD, Camille & GOURIÉROUX Christian, 2003. "Aversion Analysis," Cahiers de recherche 2003-06, Universite de Montreal, Departement de sciences economiques. [Downloadable!]
    Other versions:
    • ALLARD, Marie & BRONSARD, Camille & GOURIÉROUX, Christian, 2003. "Aversion Analysis," Cahiers de recherche 04-2003, Centre interuniversitaire de recherche en économie quantitative, CIREQ. [Downloadable!]
  2. Larry G. Epstein, 2001. "Sharing Ambiguity," American Economic Review, American Economic Association, vol. 91(2), pages 45-50, May. [Downloadable!] (restricted)
  3. Nicholas Barberis & Ming Huang & Richard H. Thaler, 2006. "Individual Preferences, Monetary Gambles, and Stock Market Participation: A Case for Narrow Framing," American Economic Review, American Economic Association, vol. 96(4), pages 1069-1090, September. [Downloadable!]
  4. David Backus & Bryan Routledge & Stanley Zin, 2004. "Exotic Preferences for Macroeconomists," NBER Working Papers 10597, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Dirk Hackbarth & Jianjun Maio, 2007. "The Dynamics of Mergers and Acquisitions in Oligopolistic Industries," Boston University - Department of Economics - Working Papers Series WP2007-017, Boston University - Department of Economics. [Downloadable!]
    Other versions:
  6. Larry Epstein & Martin Schneider, 2005. "Ambiguity, Information Quality and Asset Pricing," RCER Working Papers 519, University of Rochester - Center for Economic Research (RCER). [Downloadable!]
    Other versions:
  7. Garlappi, Lorenzo & Uppal, Raman & Wang, Tan, 2005. "Portfolio Selection with Parameter and Model Uncertainty: A Multi-Prior Approach," CEPR Discussion Papers 5148, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  8. Christopher Blattman & Jason Hwang & Jeffrey G. Williamson, 2004. "The Impact of the Terms of Trade on Economic Development in the Periphery, 1870-1939: Volatility and Secular Change," NBER Working Papers 10600, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  9. Nicholas Barberis & Ming Huang, 2006. "The Loss Aversion / Narrow Framing Approach to the Equity Premium Puzzle," NBER Working Papers 12378, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Garlappi, Lorenzo & Uppal, Raman & Wang, Tan, 2005. "Portfolio Selection with Parameter and Model Uncertainty: A Multi-Prior Approach," CEPR Discussion Papers 5041, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  11. Sbuelz, A. & Trojani, F., 2002. "Equilibrium asset pricing with time-varying pessimism," Discussion Paper 102, Tilburg University, Center for Economic Research. [Downloadable!]
  12. 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. [Downloadable!]
  13. Scott Condie, 2008. "Living with ambiguity: prices and survival when investors have heterogeneous preferences for ambiguity," Economic Theory, Springer, vol. 36(1), pages 81-108, July. [Downloadable!] (restricted)
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