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Knightian Uncertainty in Financial Markets: An Assessment
Author(s) -
Basili Marcello
Publication year - 2001
Publication title -
economic notes
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.274
H-Index - 19
eISSN - 1468-0300
pISSN - 0391-5026
DOI - 10.1111/1468-0300.00045
Subject(s) - knightian uncertainty , ambiguity , portfolio , financial market , economics , ambiguity aversion , volatility (finance) , econometrics , indeterminacy (philosophy) , mathematical economics , financial economics , microeconomics , computer science , finance , physics , quantum mechanics , programming language
If information is too vague and imprecise to be summarized by a unique additive probability measure, an agent faces Knightian uncertainty or ambiguity rather than risk. Under Knightian uncertainty, an agent's beliefs may be represented by a capacity or a set of additive probabilities. It is proved that an agent's attitude towards ambiguity has a crucial role in asset price determination and portfolio choice. Knightian uncertainty attitude provides an alternative explanation of financial market failures and enables puzzles to be solved, such as market breakdowns, price indeterminacy and volatility, bid and ask spreads, portfolio inertia, violation of call and put parity. (J.E.L.: D81, G11, G12).