Ambiguity and Volatility: Asset Pricing Implications
AbstractUsing a simple dynamic consumption-based asset pricing model, this paper explores the implications of a representative investor with smooth ambiguity averse preferences [Klibano¤, Marinacci and Mukerji, Econometrica (2005)] and provides a comparative analysis of risk aversion and ambiguity aversion. The perception of ambiguity is described by a hidden Markovian consumption growth process. The hidden states di¤er both for the mean and the volatility. We show that the ambiguity-averse investor downweights high-mean states in favor of low-mean ones. However, such distortion appears much stronger in low-volatility regimes: high volatility attenuates the distortion due to ambiguity concerns. It follows that (i) ambiguity aversion always implies higher equity premia but sustained levels of ambiguity aversion do not help explaining the high volatility of the equity premium observed in the data (volatility puzzle); (ii) our calibrated model can match the moments of the equity premium and risk free rate and can generate asset-price stylized facts like a procyclical price-dividend ratio and countercyclical conditional equity premia; however, (iii) high levels of ambiguity aversion, necessary to explain high equity returns, produce counterfactual price-dividend ratio time series across volatility states.
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Bibliographic InfoPaper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2011-042.
Date of creation: 2011
Date of revision:
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Web page: http://center.uvt.nl
Ambiguity aversion; volatility; asset pricing puzzles; robustness;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-05-14 (All new papers)
- NEP-DGE-2011-05-14 (Dynamic General Equilibrium)
- NEP-UPT-2011-05-14 (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.:
- Peter Klibanoff & Massimo Marinacci & Sujoy Mukerji, 2002.
"A smooth model of decision making under ambiguity,"
ICER Working Papers - Applied Mathematics Series
11-2003, ICER - International Centre for Economic Research, revised Apr 2003.
- Larry G. Epstein & Martin Schneider, 2008.
"Ambiguity, Information Quality, and Asset Pricing,"
Journal of Finance,
American Finance Association, vol. 63(1), pages 197-228, 02.
- Larry Epstein & Martin Schneider, 2005. "Ambiguity, Information Quality and Asset Pricing," RCER Working Papers 519, University of Rochester - Center for Economic Research (RCER).
- Larry Epstein & Martin Schneider, 2004. "Ambiguity, Information Quality and Asset Pricing," RCER Working Papers 507, University of Rochester - Center for Economic Research (RCER).
- Nengjiu Ju & Jianjun Miao, 2010.
"Ambiguity, Learning, and Asset Returns,"
CEMA Working Papers
438, China Economics and Management Academy, Central University of Finance and Economics.
- Nengjiu Ju & Jianjun Miao, . "Ambiguity, Learning, and Asset Returns," Boston University - Department of Economics - Working Papers Series wp2009-014, Boston University - Department of Economics.
- Ju, Nengjiu & Miao, Jianjun, 2009. "Ambiguity, Learning, and Asset Returns," MPRA Paper 14737, University Library of Munich, Germany, revised Apr 2009.
- Jianjun Miao & NENGJIU JU, 2010. "Ambiguity, Learning, And Asset Returns," Boston University - Department of Economics - Working Papers Series WP2010-031, Boston University - Department of Economics.
- Mark Salmon & Massimiliano Marcellino, 2001.
"Robust Decision Theory and the Lucas Critique,"
wp01-10, Warwick Business School, Finance Group.
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