Portfolio Choices and Asset Prices under EUUP: The Comparative Statics Analysis

This paper examines the standard static portfolio problem and asset pricing under the Knightian uncertainty or ambiguity. Each investor’s preference is represented by the expected utility with uncertainty probability (EUUP) of Izhakian (2017). First, We show the threshold of an ambiguity-averse (-loving) investor for whether or not she/he invests in uncertain assets is higher (lower) than that of ambiguity-neutral investors. This might give partial solution for “market participating puzzle.” Next, we show conditions under which more ambiguity aversion reduces demand for the uncertain asset. Finally, we derive the state price density (SPD). Applying the empirically estimated parameter values to the derived one, we show the shape of it is not monotone decreasing but bumped. The result shows that EUUP gives another plausible solution for “pricing kernel puzzle.”