Ambiguous Volatility, Possibility and Utility in Continuous Time

Details Ambiguous Volatility, Possibility and Utility in Continuous Time Ambiguous Volatility, Possibility and Utility in Continuous Time

2011-03-08

arxiv.org/abs/1103.1652v5

Economy

Quantitative Finance

General Finance

74 pages

Scientific paper

We formulate a model of utility for a continuous time framework that captures the decision-maker's concern with ambiguity or model uncertainty. The main novelty is in the range of model uncertainty that is accommodated. The probability measures entertained by the decision-maker are not assumed to be equivalent to a fixed reference measure and thus the model permits ambiguity about which scenarios are possible. Modeling ambiguity about volatility is a prime motivation and a major focus. Implications for asset returns are derived in representative agent frameworks, in both Arrow-Debreu style economies and in sequential Radner-style economies.

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