Robustness and Ambiguity Aversion in General Equilibrium

52 Pages Posted: 5 Apr 2004

See all articles by Fabio Trojani

Fabio Trojani

Swiss Finance Institute; University of Geneva

Paolo Vanini

University of Basel

Date Written: February 2004

Abstract

We analyze the empirical predictions arising from settings of ambiguity aversion in intertemporal heterogenous agents economies. We study equilibria for two tractable wealth-homothetic settings of ambiguity aversion in continuous time. Such settings are motivated by a different robust control optimization problem. We show that ambiguity aversion affects optimal portfolio exposures in a way that is similar to an increase in risk aversion. A distinct property of the second of our settings of ambiguity aversion is that such increase is state-dependent and highly pronounced at moderate portfolio exposures. This feature causes quite prudent levels of equity market participation over a nontrivial set of states of the economy. In general equilibrium, ambiguity aversion tends to induce a higher equilibrium equity premium and lower interest rates. A distinct feature of the second of our settings of ambiguity aversion is that the equity premium part due to ambiguity aversion dominates when the exogenous random factors in the economy have low volatility. Thus, such setting can account for some distinct empirical predictions - like a limited equity market participation and ambiguity equity premia that dominate equity premia for small equity volatilities - which are unavailable under the first of our settings of ambiguity aversion.

Keywords: Ambiguity, Financial Equilibria, Knightian Uncertainty, Model Misspecification, Perturbation Theory, Robust Decision Making

JEL Classification: C60, C61, G11

Suggested Citation

Trojani, Fabio and Vanini, Paolo, Robustness and Ambiguity Aversion in General Equilibrium (February 2004). Available at SSRN: https://ssrn.com/abstract=524685 or http://dx.doi.org/10.2139/ssrn.524685

Fabio Trojani (Contact Author)

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

University of Geneva ( email )

Geneva, Geneva
Switzerland

Paolo Vanini

University of Basel ( email )

Petersplatz 1
Basel, CH-4003
Switzerland

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
460
Abstract Views
3,607
rank
77,128
PlumX Metrics