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Ambiguity and the Language of Long Run Risk

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  • Antony Millner

Abstract

This paper investigates a duality between ambiguity averse preferences and the valuation of long run risky assets or public projects. The variational ambiguity model represents preferences over ambiguous acts via a minimization problem, and is fundamentally nonprobabilistic. In contrast, long run risky assets are ranked via a large maturity limit of expected discounted returns. Despite their apparent differences, we show that each variational ambiguity preference is a long run risk preference, and (under natural conditions) vice versa. We explore three implications: a notion of long run stochastic dominance that resolves differences between stochastic processes considered identical by standard risk measures, a typology of stochastic processes that pinpoints when a non-probabilistic description of long run risk is required, and an evolutionary foundation for variational ambiguity preferences that offers a novel explanation for ambiguity aversion.

Suggested Citation

  • Antony Millner, 2024. "Ambiguity and the Language of Long Run Risk," NBER Working Papers 33291, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:33291
    Note: AP EEE
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    More about this item

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate

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