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Continuous-time smooth ambiguity preferences

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  • Suzuki, Masataka
Abstract
This study extends the smooth ambiguity preferences model proposed by Klibanoff et al. (2005) to a continuous-time dynamic setting. It is known that the original smooth ambiguity preferences converge to the subjective expected utility as the time interval shortens so that decision makers do not exhibit any ambiguity-sensitive behavior in the continuous-time limit. Accordingly, this study proposes an alternative model of these preferences that interchanges the role of the second-order utility function with that of the second-order probability to prevent the smooth ambiguity attitude of decision maker from evaporating in the continuous-time limit. By utilizing the utility convergence results established by Kraft and Seifried (2014), our model is eventually represented by the stochastic differential utility with distorted beliefs so that most existing techniques in economics and financial studies can be made applicable together with these distorted beliefs. We give an asset-pricing example to demonstrate the applicability of our model.

Suggested Citation

  • Suzuki, Masataka, 2018. "Continuous-time smooth ambiguity preferences," Journal of Economic Dynamics and Control, Elsevier, vol. 90(C), pages 30-44.
    • Handle: RePEc:eee:dyncon:v:90:y:2018:i:c:p:30-44
    DOI: 10.1016/j.jedc.2018.01.042
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    References listed on IDEAS

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    1. Lars Peter Hansen & Thomas J Sargent, 2014. "Robust Control and Model Uncertainty," World Scientific Book Chapters, in: UNCERTAINTY WITHIN ECONOMIC MODELS, chapter 5, pages 145-154, World Scientific Publishing Co. Pte. Ltd..
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    Cited by:

    1. Asano, Takao & Osaki, Yusuke, 2021. "Optimal investment under ambiguous technology shocks," European Journal of Operational Research, Elsevier, vol. 293(1), pages 304-311.
    2. Guan, Guohui & Li, Bin, 2022. "Equilibrium investment and reinsurance strategies under smooth ambiguity with a general second-order distribution," Journal of Economic Dynamics and Control, Elsevier, vol. 143(C).
    3. Ruan, Xinfeng, 2021. "Ambiguity, long-run risks, and asset prices in continuous time," International Review of Economics & Finance, Elsevier, vol. 71(C), pages 115-126.
    4. Balter, Anne G. & Mahayni, Antje & Schweizer, Nikolaus, 2021. "Time-consistency of optimal investment under smooth ambiguity," European Journal of Operational Research, Elsevier, vol. 293(2), pages 643-657.
    5. Nicole Bauerle & Antje Mahayni, 2023. "Optimal investment in ambiguous financial markets with learning," Papers 2303.08521, arXiv.org, revised Feb 2024.
    6. Bäuerle, Nicole & Mahayni, Antje, 2024. "Optimal investment in ambiguous financial markets with learning," European Journal of Operational Research, Elsevier, vol. 315(1), pages 393-410.

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    More about this item

    Keywords

    Smooth ambiguity preferences; Continuous time; Asset pricing; Stochastic differential utility;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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