Faculty of Economics and Business Administration Publications Database

Investment behavior under ambiguity: The case of pessimistic decision makers

Authors:
Zimper, Alexander
Source:
Volume: 52
Number: 2
Pages: 111 - 130
Month: September
ISSN-Print: 0165-4896
Link External Source: Online Version
Year: 2006
Keywords: Ambiguity; Choquet expected utility theory; Bayesian updating; Pessimism; Optimism; Hyperbolic time-discounting
Abstract:

We define pessimistic, respectively optimistic, investors as CEU (Choquet expected utility) decision makers who update their pessimistic, respectively optimistic, capacities according to a pessimistic (Dempster–Shafer), respectively optimistic, update rule. We demonstrate that pessimistic rather than optimistic investors may strictly prefer investing in an illiquid asset to investing in a liquid asset. Key to our result is the dynamic inconsistency of CEU decision making, implying that a CEU decision maker ex ante prefers a different strategy with respect to prematurely liquidating an uncertain long-term investment project than after learning her liquidity needs. Investing in an illiquid asset therefore serves as a commitment device that guarantees an ex ante favorable outcome. Comparing our results with the hyperbolic time-discounting approach, we further demonstrate that pessimistic decision makers may exhibit a stronger desire for intra-personal commitment than investors with hyperbolic discount functions.

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