hero working papers

Does Uncertainty Vanish in the Small? The Smooth Ambiguity Case

Number: 391
Year: 2011
Author(s): Fabio Maccheroni, Massimo Marinacci, Doriana Ruffino
We study orders of risk and model uncertainty aversion in the smooth ambiguity model proposed by Klibano, Marinacci, and Mukerji [4]. We consider a quadratic approximation of their model and we show that both risk and model uncertainty attitudes have at most a second order effect. Specifically, the order depends on the properties of the support of the decision maker's limit prior, which we fully characterize. We find that model uncertainty attitudes have a second order effect unless the support is a singleton, that is, unless model uncertainty fades away in the limit. Special attention is given to the binomial state spaces often used in mathematical finance.