Ambiguity and portfolio decisions

Working papers | 2015 | N 67

Abstract

This paper studies the effects of ambiguity and ambiguity aversion on the demand for store-of-value assets and on the equilibrium real returns of low-relative risk assets in economies that have experienced a history of high macroeconomic and financial volatility. Applying the approach of soft preferences for ambiguity in its static version (Klibanoff et al., 2005) to a conventional portfolio selection problem, two facts of Argentine monetary history of the last twenty years are rationalized: Firstly, the dollarization of the demand for assets of the non-financial private sector. Secondly, the bias towards demanding real estate as a way of preserving the real value of wealth. It is found that ambiguity can constitute a relevant factor to explain portfolio dollarization. Additionally, the aversion to ambiguity reduces the demand for assets denominated in US dollars and increases the demand for real estate as a store of value. Subsequently, applying the soft preferences approach in its recursive version (Klibanoff et al., 2009) to an asset valuation model based on consumption and calibrating it for the Argentine case, it is found that ambiguity and aversion to ambiguity can constitute two relevant factors in determining the equilibrium values of the real returns of low relative risk assets. From a methodological perspective, the work seeks to promote the incorporation of preference representation approaches that consider ambiguity to the study of financial behaviors in economies recurrently exposed to volatile macroeconomic and financial contexts.

JEL classification: G10, G11, D14