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Ambiguity on uncertainty and the equity premium

Author

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  • Ruan, Xinfeng
  • Zhang, Jin E.

Abstract

This paper considers an asset pricing model with a multiple-priors recursive utility incorporating decision makers’ concern with ambiguity on drift and jumps of driving process. Based on our empirical evidence, given a small relative risk aversion (RRA) coefficient (e.g., RRA = 2), the model can well explain the equity premium puzzle, since the ambiguity aversion, as a complementary aversion of the risk aversion, can increase the equity premium and decrease the risk-free rate. This paper documents that ambiguity on uncertainty is a resolution of the equity premium puzzle.

Suggested Citation

  • Ruan, Xinfeng & Zhang, Jin E., 2021. "Ambiguity on uncertainty and the equity premium," Finance Research Letters, Elsevier, vol. 38(C).
    • Handle: RePEc:eee:finlet:v:38:y:2021:i:c:s1544612319312176
    DOI: 10.1016/j.frl.2020.101429
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    References listed on IDEAS

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    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
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    Cited by:

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    3. Yan, Jingzhou & Mu, Congming & Yan, Qianhui & Luo, Deqing, 2023. "Robust leverage choice of hedge funds with rare disasters," Finance Research Letters, Elsevier, vol. 54(C).

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    More about this item

    Keywords

    Ambiguity; Multiple priors; Equity premium puzzle;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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