Investor Behavior Under Epistemic vs. Aleatory Uncertainty

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.

Automated summary

We find that investor behavior is influenced by two dimensions of subjective uncertainty: epistemic uncertainty (missing knowledge, skill, or information) and aleatory uncertainty (chance or stochastic processes). Investors who perceive higher epistemic uncertainty are more likely to seek expert guidance and use available information, while those perceiving higher aleatory uncertainty are more inclined to diversify and their risk preferences better predict their investment choices. We also demonstrate that the presentation format of historical information can influence uncertainty attributions, with charts of absolute stock prices promoting perceptions of epistemicness and willingness to pay for financial advice, while charts of price changes promoting perceptions of aleatoriness and a tendency to diversify.