IDEAS home Printed from https://ideas.repec.org/a/eee/jetheo/v222y2024ics0022053124001285.html
   My bibliography  Save this article

Ambiguity, information processing, and financial intermediation

Author

Listed:
  • Han, Leyla Jianyu
  • Kasa, Kenneth
  • Luo, Yulei

Abstract

This paper incorporates ambiguity and information processing constraints into the He and Krishnamurthy (2012) model of intermediary asset pricing. Financial intermediaries possess greater information processing capacity than households. In response, households optimally choose to delegate their investment decisions. The contractual relationship between households and intermediaries is subject to a moral hazard friction, which results in a financial constraint. We show that ambiguity aversion not only amplifies households' incentives to delegate but also tightens the financial constraint. The calibrated model can quantitatively explain both the unconditional and time-varying moments of observed asset prices while endogenously generating an empirically consistent crisis frequency.

Suggested Citation

  • Han, Leyla Jianyu & Kasa, Kenneth & Luo, Yulei, 2024. "Ambiguity, information processing, and financial intermediation," Journal of Economic Theory, Elsevier, vol. 222(C).
    • Handle: RePEc:eee:jetheo:v:222:y:2024:i:c:s0022053124001285
    DOI: 10.1016/j.jet.2024.105922
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0022053124001285
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jet.2024.105922?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Valentin Haddad & Tyler Muir, 2021. "Do Intermediaries Matter for Aggregate Asset Prices?," Journal of Finance, American Finance Association, vol. 76(6), pages 2719-2761, December.
    2. Boyarchenko, Nina, 2012. "Ambiguity shifts and the 2007–2008 financial crisis," Journal of Monetary Economics, Elsevier, vol. 59(5), pages 493-507.
    3. Tobias Adrian & Nina Boyarchenko, 2012. "Intermediary leverage cycles and financial stability," Staff Reports 567, Federal Reserve Bank of New York.
    4. Zhiguo He & Arvind Krishnamurthy, 2019. "A Macroeconomic Framework for Quantifying Systemic Risk," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(4), pages 1-37, October.
    5. Mark Gertler & Nobuhiro Kiyotaki & Andrea Prestipino, 2020. "A Macroeconomic Model with Financial Panics," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 87(1), pages 240-288.
    6. Lars Peter Hansen & Thomas J Sargent, 2014. "Robust Control and Model Misspecification," World Scientific Book Chapters, in: UNCERTAINTY WITHIN ECONOMIC MODELS, chapter 6, pages 155-216, World Scientific Publishing Co. Pte. Ltd..
    7. Zhigu He & Arvind Krishnamurthy, 2012. "A Model of Capital and Crises," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(2), pages 735-777.
    8. Lars Peter Hansen & Thomas J Sargent, 2014. "Doubts or Variability?," World Scientific Book Chapters, in: UNCERTAINTY WITHIN ECONOMIC MODELS, chapter 7, pages 217-256, World Scientific Publishing Co. Pte. Ltd..
    9. Hansen, Lars Peter & Sargent, Thomas J., 2011. "Robustness and ambiguity in continuous time," Journal of Economic Theory, Elsevier, vol. 146(3), pages 1195-1223, May.
    10. Peng, Lin, 2005. "Learning with Information Capacity Constraints," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(2), pages 307-329, June.
    11. Lewellen, Jonathan, 2011. "Institutional investors and the limits of arbitrage," Journal of Financial Economics, Elsevier, vol. 102(1), pages 62-80, October.
    12. Hongjun Yan, 2008. "Natural Selection in Financial Markets: Does It Work?," Management Science, INFORMS, vol. 54(11), pages 1935-1950, November.
    13. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393, Elsevier.
    14. Nengjiu Ju & Jianjun Miao, 2012. "Ambiguity, Learning, and Asset Returns," Econometrica, Econometric Society, vol. 80(2), pages 559-591, March.
    15. Zhiguo He & Arvind Krishnamurthy, 2013. "Intermediary Asset Pricing," American Economic Review, American Economic Association, vol. 103(2), pages 732-770, April.
    16. Marianne Andries & Valentin Haddad, 2020. "Information Aversion," Journal of Political Economy, University of Chicago Press, vol. 128(5), pages 1901-1939.
    17. Raman Uppal & Tan Wang, 2003. "Model Misspecification and Underdiversification," Journal of Finance, American Finance Association, vol. 58(6), pages 2465-2486, December.
    18. Valentin Haddad & Tyler Muir, 2021. "Do Intermediaries Matter for Aggregate Asset Prices?," NBER Working Papers 28692, National Bureau of Economic Research, Inc.
    19. Larry G. Epstein & Martin Schneider, 2010. "Ambiguity and Asset Markets," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 315-346, December.
    20. Cochrane, John H, 1989. "The Sensitivity of Tests of the Intertemporal Allocation of Consumption to Near-Rational Alternatives," American Economic Review, American Economic Association, vol. 79(3), pages 319-337, June.
    21. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
    22. Jonathan B. Berk & Richard C. Green, 2004. "Mutual Fund Flows and Performance in Rational Markets," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1269-1295, December.
    23. Ron Kaniel & Péter Kondor, 2013. "The Delegated Lucas Tree," The Review of Financial Studies, Society for Financial Studies, vol. 26(4), pages 929-984.
    24. Bidder, R.M. & Smith, M.E., 2012. "Robust animal spirits," Journal of Monetary Economics, Elsevier, vol. 59(8), pages 738-750.
    25. Robert J. Barro, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 121(3), pages 823-866.
    26. Hansen, Lars Peter & Sargent, Thomas J., 2007. "Recursive robust estimation and control without commitment," Journal of Economic Theory, Elsevier, vol. 136(1), pages 1-27, September.
    27. Tobias Adrian & Nina Boyarchenko, 2012. "Intermediary leverage cycles and financial stability," Staff Reports 567, Federal Reserve Bank of New York, revised 01 Feb 2015.
    28. Philipp K. Illeditsch & Jayant V. Ganguli & Scott Condie, 2021. "Information Inertia," Journal of Finance, American Finance Association, vol. 76(1), pages 443-479, February.
    29. Mohammad R. Jahan-Parvar & Hening Liu, 2014. "Ambiguity Aversion and Asset Prices in Production Economies," The Review of Financial Studies, Society for Financial Studies, vol. 27(10), pages 3060-3097.
    30. Michaela Pagel, 2018. "A News‐Utility Theory for Inattention and Delegation in Portfolio Choice," Econometrica, Econometric Society, vol. 86(2), pages 491-522, March.
    31. Smith, A A, Jr, 1993. "Estimating Nonlinear Time-Series Models Using Simulated Vector Autoregressions," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 8(S), pages 63-84, Suppl. De.
    32. Jaroslav Borovička, 2020. "Survival and Long-Run Dynamics with Heterogeneous Beliefs under Recursive Preferences," Journal of Political Economy, University of Chicago Press, vol. 128(1), pages 206-251.
    33. Berk, Jonathan B. & van Binsbergen, Jules H., 2015. "Measuring skill in the mutual fund industry," Journal of Financial Economics, Elsevier, vol. 118(1), pages 1-20.
    34. Pascal J. Maenhout, 2004. "Robust Portfolio Rules and Asset Pricing," The Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 951-983.
    35. Kacperczyk, Marcin & Nosal, Jaromir & Stevens, Luminita, 2019. "Investor sophistication and capital income inequality," Journal of Monetary Economics, Elsevier, vol. 107(C), pages 18-31.
    36. David Easley & Maureen O'Hara & Liyan Yang, 2014. "Opaque Trading, Disclosure, and Asset Prices: Implications for Hedge Fund Regulation," The Review of Financial Studies, Society for Financial Studies, vol. 27(4), pages 1190-1237.
    37. Mark Gertler & Nobuhiro Kiyotaki, 2015. "Banking, Liquidity, and Bank Runs in an Infinite Horizon Economy," American Economic Review, American Economic Association, vol. 105(7), pages 2011-2043, July.
    38. Lars Peter Hansen & Thomas J Sargent, 2014. "A Quartet of Semigroups for Model Specification, Robustness, Prices of Risk, and Model Detection," World Scientific Book Chapters, in: UNCERTAINTY WITHIN ECONOMIC MODELS, chapter 4, pages 83-143, World Scientific Publishing Co. Pte. Ltd..
    39. Hongjun Yan, 2008. "Natural Selection in Financial Markets: Does It Work?," Management Science, INFORMS, vol. 54(11), pages 1935-1950, November.
    40. Peter Klibanoff & Massimo Marinacci & Sujoy Mukerji, 2005. "A Smooth Model of Decision Making under Ambiguity," Econometrica, Econometric Society, vol. 73(6), pages 1849-1892, November.
    41. Jianjun Miao & Alejandro Rivera, 2016. "Robust Contracts in Continuous Time," Econometrica, Econometric Society, vol. 84(4), pages 1405-1440, July.
    42. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
    43. A Ronald Gallant & Mohammad R Jahan-Parvar & Hening Liu, 2019. "Does Smooth Ambiguity Matter for Asset Pricing?," The Review of Financial Studies, Society for Financial Studies, vol. 32(9), pages 3617-3666.
    44. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
    45. Philipp Karl Illeditsch, 2011. "Ambiguous Information, Portfolio Inertia, and Excess Volatility," Journal of Finance, American Finance Association, vol. 66(6), pages 2213-2247, December.
    46. Yulei Luo, 2010. "Rational Inattention, Long-run Consumption Risk, and Portfolio Choice," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(4), pages 843-860, October.
    47. Adrien D'Avernas & Quentin Vandeweyer, 2024. "Treasury Bill Shortages and the Pricing of Short‐Term Assets," Journal of Finance, American Finance Association, vol. 79(6), pages 4083-4141, December.
    48. Huang, Shiyang & Qiu, Zhigang & Yang, Liyan, 2020. "Institutionalization, delegation, and asset prices," Journal of Economic Theory, Elsevier, vol. 186(C).
    49. Yulei Luo, 2017. "Robustly Strategic Consumption–Portfolio Rules with Informational Frictions," Management Science, INFORMS, vol. 63(12), pages 4158-4174, December.
    50. Itay Goldstein & Liyan Yang, 2015. "Information Diversity and Complementarities in Trading and Information Acquisition," Journal of Finance, American Finance Association, vol. 70(4), pages 1723-1765, August.
    51. Kenneth R. French, 2008. "Presidential Address: The Cost of Active Investing," Journal of Finance, American Finance Association, vol. 63(4), pages 1537-1573, August.
    52. Markus K. Brunnermeier & Yuliy Sannikov, 2014. "A Macroeconomic Model with a Financial Sector," American Economic Review, American Economic Association, vol. 104(2), pages 379-421, February.
    53. Markus K. Brunnermeier & Yuliy Sannikov, 2012. "A macroeconomic model with a financial sector," Working Paper Research 236, National Bank of Belgium.
    54. Jerry Tsai & Jessica A. Wachter, 2015. "Disaster Risk and its Implications for Asset Pricing," NBER Working Papers 20926, National Bureau of Economic Research, Inc.
    55. John H. Cochrane, 2011. "Presidential Address: Discount Rates," Journal of Finance, American Finance Association, vol. 66(4), pages 1047-1108, August.
    56. Luo, Yulei & Young, Eric R., 2016. "Induced uncertainty, market price of risk, and the dynamics of consumption and wealth," Journal of Economic Theory, Elsevier, vol. 163(C), pages 1-41.
    57. David Easley & Maureen O'Hara, 2009. "Ambiguity and Nonparticipation: The Role of Regulation," The Review of Financial Studies, Society for Financial Studies, vol. 22(5), pages 1817-1843, May.
    58. repec:nas:journl:v:115:y:2018:p:9163-9168 is not listed on IDEAS
    59. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
    60. Jerry Tsai & Jessica A. Wachter, 2015. "Disaster Risk and Its Implications for Asset Pricing," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 219-252, December.
    61. Emi Nakamura & Jón Steinsson & Robert Barro & José Ursúa, 2013. "Crises and Recoveries in an Empirical Model of Consumption Disasters," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 35-74, July.
    62. He, Zhiguo & Kelly, Bryan & Manela, Asaf, 2017. "Intermediary asset pricing: New evidence from many asset classes," Journal of Financial Economics, Elsevier, vol. 126(1), pages 1-35.
    63. Zhiguo He & Arvind Krishnamurthy, 2018. "Intermediary Asset Pricing and the Financial Crisis," Annual Review of Financial Economics, Annual Reviews, vol. 10(1), pages 173-197, November.
    64. Robin Greenwood & David Scharfstein, 2013. "The Growth of Finance," Journal of Economic Perspectives, American Economic Association, vol. 27(2), pages 3-28, Spring.
    65. Guillermo Ordoñez, 2013. "The Asymmetric Effects of Financial Frictions," Journal of Political Economy, University of Chicago Press, vol. 121(5), pages 844-895.
    66. Dow, James & Werlang, Sergio Ribeiro da Costa, 1992. "Uncertainty Aversion, Risk Aversion, and the Optimal Choice of Portfolio," Econometrica, Econometric Society, vol. 60(1), pages 197-204, January.
    67. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    68. Marcin Kacperczyk & Stijn Van Nieuwerburgh & Laura Veldkamp, 2016. "A Rational Theory of Mutual Funds' Attention Allocation," Econometrica, Econometric Society, vol. 84, pages 571-626, March.
    69. Taylor, Daniel J. & Verrecchia, Robert E., 2015. "Delegated trade and the pricing of public and private information," Journal of Accounting and Economics, Elsevier, vol. 60(2), pages 8-32.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Leyla Jianyu Han & Kenneth Kasa, 2019. "Ambiguity and Information Processing in a Model of Intermediary Asset Pricing," Discussion Papers dp19-04, Department of Economics, Simon Fraser University.
    2. Cosmin L. Ilut & Martin Schneider, 2022. "Modeling Uncertainty as Ambiguity: a Review," NBER Working Papers 29915, National Bureau of Economic Research, Inc.
    3. Agarwal, Vikas & Arisoy, Y. Eser & Naik, Narayan Y., 2017. "Volatility of aggregate volatility and hedge fund returns," Journal of Financial Economics, Elsevier, vol. 125(3), pages 491-510.
    4. Kai Li & Chenjie Xu, 2023. "Asset pricing with a financial sector," Financial Management, Financial Management Association International, vol. 52(1), pages 67-95, March.
    5. Massimo Guidolin & Francesca Rinaldi, 2013. "Ambiguity in asset pricing and portfolio choice: a review of the literature," Theory and Decision, Springer, vol. 74(2), pages 183-217, February.
    6. Nengjiu Ju & Jianjun Miao, 2012. "Ambiguity, Learning, and Asset Returns," Econometrica, Econometric Society, vol. 80(2), pages 559-591, March.
    7. Li, Zehao, 2022. "Financial intermediary leverage and monetary policy transmission," European Economic Review, Elsevier, vol. 144(C).
    8. Semyon Malamud & Andreas Schrimpf, 2016. "Intermediation Markups and Monetary Policy Passthrough," Swiss Finance Institute Research Paper Series 16-75, Swiss Finance Institute.
    9. Andrea Ajello & Nina Boyarchenko & François Gourio & Andrea Tambalotti, 2022. "Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms," Staff Reports 1002, Federal Reserve Bank of New York.
    10. Yacine Aït-Sahalia & Felix Matthys & Emilio Osambela & Ronnie Sircar, 2021. "When Uncertainty and Volatility Are Disconnected: Implications for Asset Pricing and Portfolio Performance," NBER Working Papers 29195, National Bureau of Economic Research, Inc.
    11. Bidder, R.M. & Smith, M.E., 2018. "Doubts and variability: A robust perspective on exotic consumption series," Journal of Economic Theory, Elsevier, vol. 175(C), pages 689-712.
    12. Tyler Muir, 2017. "Financial Crises and Risk Premia," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 132(2), pages 765-809.
    13. Buffa, Andrea M. & Hodor, Idan, 2023. "Institutional investors, heterogeneous benchmarks and the comovement of asset prices," Journal of Financial Economics, Elsevier, vol. 147(2), pages 352-381.
    14. Jang, Bong-Gyu & Lee, Seungkyu & Lim, Byung Hwa, 2016. "Robust consumption and portfolio rules with time-varying model confidence," Finance Research Letters, Elsevier, vol. 18(C), pages 342-352.
    15. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    16. Li, Kai & Xu, Chenjie, 2024. "Intermediary-based equity term structure," Journal of Financial Economics, Elsevier, vol. 157(C).
    17. Philipp K. Illeditsch & Jayant V. Ganguli & Scott Condie, 2021. "Information Inertia," Journal of Finance, American Finance Association, vol. 76(1), pages 443-479, February.
    18. repec:esx:essedp:770 is not listed on IDEAS
    19. Sujoy Mukerji & Han N. Ozsoylev & Jean‐Marc Tallon, 2023. "Trading Ambiguity: A Tale Of Two Heterogeneities," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 64(3), pages 1127-1164, August.
    20. Meyer-Gohde, Alexander, 2019. "Generalized entropy and model uncertainty," Journal of Economic Theory, Elsevier, vol. 183(C), pages 312-343.
    21. Jiang, Julia & Liu, Jun & Tian, Weidong & Zeng, Xudong, 2022. "Portfolio concentration, portfolio inertia, and ambiguous correlation," Journal of Economic Theory, Elsevier, vol. 203(C).

    More about this item

    Keywords

    Ambiguity; Rational inattention; Portfolio delegation; Intermediary asset pricing; Financial crisis;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jetheo:v:222:y:2024:i:c:s0022053124001285. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/622869 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.