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New Formulations of Ambiguous Volatility with an Application to Optimal Dynamic Contracting

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  • Peter G. Hansen

Abstract

I introduce novel preference formulations which capture aversion to ambiguity about unknown and potentially time-varying volatility. I compare these preferences with Gilboa and Schmeidler's maxmin expected utility as well as variational formulations of ambiguity aversion. The impact of ambiguity aversion is illustrated in a simple static model of portfolio choice, as well as a dynamic model of optimal contracting under repeated moral hazard. Implications for investor beliefs, optimal design of corporate securities, and asset pricing are explored.

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  • Peter G. Hansen, 2021. "New Formulations of Ambiguous Volatility with an Application to Optimal Dynamic Contracting," Papers 2101.12306, arXiv.org.
    • Handle: RePEc:arx:papers:2101.12306
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    References listed on IDEAS

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