"Heterogeneous awareness in financial markets" with F. Severino, Journal of Economic Behavior & Organization (2023), 216, 26-41
The overlook of some economic scenarios may result in unforeseen negative outcomes for investors. In this paper, we consider an order-driven financial market in which a fraction of the traders is only partially aware of the possible payoffs of a risky asset, but is aware of the possibility of facing unknown contingencies. Investors decide whether to acquire a costly signal about the payoff of the risky asset and whether to buy such asset given their awareness level and their perceived relations among signals, order flows, and prices. We show that as unawareness becomes more severe, the value of the signal to the partially aware traders diminishes. In turn, through its impact on the price, the reduced number of partially aware informed investors increases the incentives of the fully aware to acquire the signal. In the aggregate, the latter effect does not outweigh the former, so that the overall proportion of informed investors in the market is (weakly) decreasing in the unawareness level. As for the equilibrium price, a lower amount of informed traders makes it more difficult for market makers to distinguish between good and bad signals, and this brings the conditional expectations of the price closer to the unconditional one and reduces the price variance.
“A Generalized Approach for the Modeling of Goodwin-Type Cycles” with M. Gaudenzi and F. Zanolin, Advanced Nonlinear Studies (2016), 16(4), 775-793
Unawareness in portfolio optimization” with F. Severino, A.Pankratov and N.Kolani
Unawareness of Outcomes in Innovative Activities
Individuals engaging in innovative activities often end up facing issues or achieving results that initially were not even imaginable. I study the problem of an agent deciding whether to undertake an innovative project, such as founding a startup. The agent is not aware of all the possible outcomes of the project, but is aware of his bounded awareness. Under a natural consistency condition on beliefs, awareness of unawareness implies a reduced value of information. As a result, pessimistic individuals are discouraged from entering entrepreneurship, while optimistic ones experiment less and persist more. This sheds new light on the empirical puzzle that many individuals seem to enter and persist in entrepreneurship despite earning low returns. I provide empirical predictions on the association among certain characteristics of entrepreneurship as a function of agents' attitudes towards unawareness. Such associations differ from those generated by a model where individuals are fully aware and entrepreneurship is driven by non-pecuniary benefits.
Learning Under Awareness of Unawareness
In this paper, I develop a simple choice theoretic model of learning under limited awareness of outcomes. A decision maker conducts a series of clinical trials and in each period she observes only an imprecise measure of the outcome, and uses a likelihood test to decide whether an observation is the result of a known outcome plus a measurement error or of an unknown effect. First, I show that for an agent who does not incorporate new discoveries in her treatments, a sort of negative feedback effect in her ability to learn good new outcomes emerges. In particular, the discovery of a beneficial effect increases the perceived likelihood of good outcomes and, in addition, induces the agent to choose treatments involving more extreme effects. Both these reactions inhibit the decision maker's ability to recognize other new favorable outcomes. The changes in the perceived likelihoods and in the optimal treatment instead work in opposite directions when evaluating the impact of new discoveries on the agent's ability to detect adverse side effects. In this case, the ultimate result depends on her sensitivity towards measurement errors, with high sensitivity inducing a positive feedback effect. Finally, I study how an agent's willingness to experiment affects her ability to learn. I show that when new outcomes are sufficiently more extreme than the known ones a decision maker who never experiments learns more, whereas such new outcomes make an agent who loves to experiment more capable of recognizing moderate new effects.