Investor Behavior Under Epistemic vs. Aleatory Uncertainty

Abstract

We provide evidence that investor behavior is sensitive to two dimensions of subjective uncertainty concerning future asset values. Investors vary in the extent to which they attribute market uncertainty to (1) missing knowledge, skill, or information (epistemic uncertainty) and (2) chance or stochastic processes (aleatory uncertainty). Investors who view stock market uncertainty as higher in epistemicness (knowability) are more likely to reduce uncertainty by seeking guidance from experts and are more responsive more responsive to available information when choosing whether to invest. In contrast, investors who view stock market uncertainty as higher in aleatoriness (randomness) are more likely to reduce uncertainty through diversification, and their risk preferences better predict whether they choose to invest. We show, further, that attributions of uncertainty can be perturbed by the format in which historical information is presented: charts displaying absolute stock prices promote perceptions of epistemicness and greater willingness to pay for financial advice, whereas charts displaying the change in stock prices from one period to the next promote perceptions of aleatoriness and a greater tendency to diversify. This paper was accepted by Yuval Rottenstreich, behavioral economics and decision analysis. Funding: This material is based upon work supported by the National Science Foundation [Grant SES-1427469] to C. R. Fox and Gülden Ülkümen. Additional support for this work was provided by INSEAD and UCLA Anderson School of Management. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4489 .