Optimal Investment and Equilibrium Pricing under Ambiguity
Abstract
We consider portfolio selection under nonparametric -maxmin ambiguity in the neighbourhood of a reference distribution. We show strict concavity of the portfolio problem under ambiguity aversion. Implied demand functions are nondifferentiable, resemble observed bid-ask spreads, and are consistent with existing parametric limiting participation results under ambiguity. Ambiguity seekers exhibit a discontinuous demand function, implying an empty set of reservation prices. If agents have identical, or sufficiently similar prior beliefs, the first-best equilibrium is no trade. Simple conditions yield the existence of a Pareto-efficient second-best equilibrium, implying that heterogeneity in ambiguity preferences is sufficient for mutually beneficial transactions among all else homogeneous traders. These equilibria reconcile many observed phenomena in liquid high-information financial markets, such as liquidity dry-ups, portfolio inertia, and negative risk premia.
Keywords
Cite
@article{arxiv.2206.10489,
title = {Optimal Investment and Equilibrium Pricing under Ambiguity},
author = {Michail Anthropelos and Paul Schneider},
journal= {arXiv preprint arXiv:2206.10489},
year = {2022}
}