The decision-makers’ ambiguity attitude determines how and to what extent such uncertainty affects their choices. “Alternatively, think about ambiguity as uncertainty about the ‘true’ probability distribution governing future paths of state variables. “Knightian uncertainty…disentangles risk from uncertainty…Roughly speaking, risk refers to the situation where there is a probability measure to guide a choice, while ambiguity refers to the situation where the decision-maker is uncertain about this probability measure due to cognitive or informational constraints.” The post ties up with this site’s summary on endogenous market risk, particularly the section on exit risk. The below are condensed annotated quotes of the comprehensive summary paper.Ĭursive text and text in brackets have been added for clarity. Washington: Board of Governors of the Federal Reserve System. “What is Certain about Uncertainty?,” International Finance Discussion Papers 1294. Jahan-Parvar, Francesca Loria, Sai Ma, Marius Rodriguez, and Ilknur Zer (2020). Londono, John Rogers, Deepa Datta, Thiago Ferreira, Olesya Grishchenko, Mohammad R. Third, the level of public and market uncertainty is indicative of risk premia offered across asset classes.Ĭascaldi-Garcia, Danilo, Cisil Sarisoy, Juan M. Second, changes in uncertainty indicators often predict near-term flows in and out of risky asset classes. First, uncertainty measures provide a basis for comparing the market’s assessment of risk with private information and research. The benefits for macro trading are threefold. There are various types of measures seeking to estimate risk and uncertainty: realized and derivatives-implied distributions of returns across assets, news-based measures of policy and political uncertainty, survey-based indicators, econometric measures, and ambiguity indices. Uncertainty is a broader concept that encompasses ambiguity about the parameters of this probability distribution. In financial markets, risk refers to the probability distribution of future returns.
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