Ani Guerdjikova

Survival with Ambiguity

We analyze a market populated by expected utility maximizers and smooth ambiguity-averse consumers. We study conditions under which ambiguity-averse consumers survive and affect prices in the limit. If ambiguity vanishes with time or if the economy exhibits no aggregate risk, ambiguity-averse consumers survive, but have no long-run impact on prices. In both scenarios ambiguity-averse consumers are fully insured against ambiguity in equilibrium and thus behave as expected utility maximizers with correct beliefs. If ambiguity-averse consumers are not fully insured against ambiguity, their behavior mimics expected utility maximizers with wrong beliefs and a stochastic discount factor which might be consistently higher or lower than their actual discount factor. We use this insight to analyze a Markov economy with large persistent ambiguity. Consumers with decreasing absolute ambiguity aversion whose prudence with respect to ambiguity exceeds twice their absolute ambiguity aversion a.s. survive in the presence of expected utility maximizers with correct beliefs. If the economy further exhibits aggregate risk, they drive the expected utility maximizers out of the market and determine prices in the limit. In contrast, consumers with increasing or constant absolute ambiguity aversion only survive in the absence of aggregate risk and have no impact on limit prices.

Case-based belief formation under ambiguity

In this paper, we consider a decision maker who tries to learn the distribution of outcomes from previously observed cases. For each observed database of cases the decision maker predicts a set of priors expressing his beliefs about the underlying probability distribution. We impose a version of the concatenation axiom introduced in Billot et al. (2005) which ensures that the sets of priors can be represented as a weighted sum of the observed frequencies of cases. The weights are the uniquely determined similarities between the observed cases and the case under investigation. The predicted probabilities, however, may vary with the number of observations. This generalization of Billot et al. (2005) allows one to model learning processes.

Ambiguity, data and preferences for information – A case-based approach

We model decision making under ambiguity based on available data. Decision makers express preferences over actions and data sets. We derive an α-max–min representation of preferences, in which beliefs combine objective characteristics of the data (number and frequency of observations) with subjective features of the decision maker (similarity of observations and perceived ambiguity). We identify the subjectively perceived ambiguity and separate it into ambiguity due to a limited number of observations and ambiguity due to data heterogeneity. The special case of no ambiguity provides a behavioral foundation for beliefs as similarity-weighted frequencies as in Billot et al. (2005) [3].

TECHNOLOGY ADOPTION AND ADAPTATION TO CLIMATE CHANGE — A CASE-BASED APPROACH

We present a model of technological adaptation in response to a change in climate conditions. The main feature of the model is that new technologies are not just risky, but also ambiguous. Pessimistic agents are thus averse to adopting a new technology. Learning is induced by optimists, who are willing to try out technologies about which there is little evidence available. We show that both optimists and pessimists are crucial for a successful adaptation. While optimists provide the public good of information which gives pessimists an incentive to innovate, pessimists choose the new technology persistently in the long-run which increases the average returns for the society. Hence, the optimal share of optimists in the society is strictly positive. When the share of optimists in the society is too low, innovation is slow and the obtained steady-state is inefficient. We discuss two policies which can potentially alleviate this inefficiency: Subsidies and provision of additional information. We show that if precise and relevant information is available, pessimists would be willing to pay for it and consequently adopt the new technology. Hence, providing information might be a more efficient policy, which is both self-financing and results in better social outcomes.

Institutions and growth in limited access societies

We build a dynamic political economy model with a two-class society, workers and the elite, in which the elite formation, the innovation rate and fiscal policy are endogenous. The model generates a mapping between institutions and patterns of growth consistent with empirical evidence. Ex ante, when facing constraints in choosing institutions, the elite may delegate policy control to some of its members, even though such delegation exacerbates the conflict within the elite and causes policy failures. Committing to such institutional arrangements prevents more harmful outcomes, such as rapid entry and subsequent deterioration of the elite[modifier letter apostrophe]s economic and political power.

Portfolio Choice and Asset Prices in an Economy Populated by Case-Based Decision Makers

I consider an economy populated by case-based decision makers. Consumption can be transferred between the periods by means of a riskless storage technology or a risky asset with i.i.d. dividend payments. I analyze the dynamics of asset holdings and asset prices and identify the influence of the aspiration level, the length of memory and the form of the similarity function. The height of the aspiration level determines whether the economy exhibits constant prices and asset holdings or evolves in a cycle. The length of memory is associated with the ability of the investors to learn the correct distribution of returns, whereas the form of the similarity function influences the willingness of investors to diversify.

Do markets prove pessimists right

We study how ambiguity and ambiguity attitudes affect asset prices when consumers form their expectations based on past observations. In an overlapping generations economy with risk‐neutral yet ambiguity‐sensitive consumers, we describe limiting asset prices depending on the proportion of investor types. We then study the evolution of consumer‐type shares. With long memory, the market does not select for ambiguity neutrality. Whenever perceived ambiguity is sufficiently small, but positive, only pessimists survive and determine prices in the limit. With one‐period memory, equilibrium prices are determined by Bayesians. Yet, the average price of the risky asset is lower than its fundamental value.

Preference for Diversification with Similarity Considerations

The paper studies the connection between the form of the similarity function of a decision-maker and his willingness to diversify. It is shown that preference for diversification obtain for both high and low aspiration levels if the similarity function is convex in the Euclidean distance. However, a decision-maker with a concave similarity function and relatively high aspiration level will fail to choose diversified acts, even if his utility function is concave.