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Does Ambiguity Generate Demand for Options?

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  • Takashi Nishiwaki

    (Graduate School of Economics, Waseda University)

Abstract

This study examinesthe optimal investment strategies for risk-and-ambiguity averse investors and characterizes conditions under which ambiguity induces investors to buy or sell options. Under identical constant relative risk aversion utility functions, we show that ambiguity-averse investors should sell portfolio insurance. In particular, when investors' relative risk aversion is less than or equal to two, ambiguity-averse investors should sell options at any realization values of a reference asset. In addition, if the relative risk aversion is greater than two, we demonstrate that ambiguity-averse investors should sell options at smaller and buy them at higher realization values of the reference portfolio.

Suggested Citation

  • Takashi Nishiwaki, 2020. "Does Ambiguity Generate Demand for Options?," Working Papers 2011, Waseda University, Faculty of Political Science and Economics.
    • Handle: RePEc:wap:wpaper:2011
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    More about this item

    Keywords

    Ambiguity; Multiple prior model; Options demand; Kullback-Leibler divergence;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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