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 .
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. A motivating application is the extension of asset pricing theory to incorporate ambiguity about volatility and possibility. The paper provides some initial steps in this direction by deriving equilibrium relations for asset returns in a representative agent framework, by deriving hedging bounds for asset prices, and by showing the pivotal role of `state prices' in both the equilibrium and no-arbitrage analyses .
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Implications
A motivating application is the extension of asset pricing theory to incorporate ambiguity about volatility and possibility. The paper provides some initial steps in this direction by deriving equilibrium relations
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are derived in representative agent frameworks,
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both Arrow-Debreu style economies and in sequential Radner-style economies
a representative agent framework, by deriving hedging bounds for asset prices, and by showing the pivotal role of `state prices' in both the equilibrium and no-arbitrage analyses