Ambiguous Volatility and Asset Pricing in Continuous Time
AbstractThis paper formulates a model of utility for a continuous time frame-work that captures the decision-maker’s concern with ambiguity about both volatility and drift. Corresponding extensions of some basic results in asset pricing theory are presented. First, we derive arbitrage-free pricing rules based on hedging arguments. Ambiguous volatility implies market incompleteness that rules out perfect hedging. Consequently, hedging arguments determine prices only up to intervals. However, sharper predictions can be obtained by assuming preference maximization and equilibrium. Thus we apply the model of utility to a representative agent endowment economy to study equilibrium asset returns. A version of the C-CAPM is derived and the effects of ambiguous volatility are described.
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Bibliographic InfoPaper provided by CIRANO in its series CIRANO Working Papers with number 2012s-29.
Date of creation: 01 Nov 2012
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ambiguity; option pricing; recursive utility; G-Brownian motion; robust stochastic volatility; sentiment; overconfidence; optimism.;
Other versions of this item:
- Larry G. Epstein & Shaolin Ji, 2013. "Ambiguous Volatility and Asset Pricing in Continuous Time," Review of Financial Studies, Society for Financial Studies, vol. 26(7), pages 1740-1786.
- Larry G. Epstein & Shaolin Ji, 2013. "Ambiguous volatility and asset pricing in continuous time," Papers 1301.4614, arXiv.org.
- NEP-ALL-2012-12-10 (All new papers)
- NEP-MIC-2012-12-10 (Microeconomics)
- NEP-UPT-2012-12-10 (Utility Models & Prospect Theory)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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