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arXiv · 2101.12306

New Formulations of Ambiguous Volatility with an Application to Optimal Dynamic Contracting

Peter G. Hansen
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Abstract

I introduce novel preference formulations which capture aversion to ambiguity about unknown and potentially time-varying volatility. I compare these preferences with Gilboa and Schmeidler's maxmin expected utility as well as variational formulations of ambiguity aversion. The impact of ambiguity aversion is illustrated in a simple static model of portfolio choice, as well as a dynamic model of optimal contracting under repeated moral hazard. Implications for investor beliefs, optimal design of corporate securities, and asset pricing are explored.

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Peter G. Hansen. 2021-01-28. New Formulations of Ambiguous Volatility with an Application to Optimal Dynamic Contracting. https://arxiv.org/abs/2101.12306

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