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Robustness and Ambiguity Aversion in General Equilibrium

  • Fabio Trojani
  • Paolo Vanini

We analyze the empirical predictions of ambiguity aversion in intertemporal heterogenous agents economies. We examine equilibria for two tractable wealth--homothetic settings of ambiguity aversion in continuous time. Each setting is motivated by a different robust control optimization problem. We show that ambiguity aversion affects optimal portfolios in a way that is similar to an increase in risk aversion. A distinct property of our second setting of ambiguity aversion is that this increase is state dependent, highly pronounced at moderate portfolio exposures and reduces equity-market participation. In general equilibrium, ambiguity aversion raises the equity premium and lowers interest rates. A distinct feature of our second setting of ambiguity aversion is that the equity premium part due to ambiguity aversion dominates when volatility is low.

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Article provided by Springer in its journal European Finance Review.

Volume (Year): 8 (2004)
Issue (Month): 2 ()
Pages: 279-324

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Handle: RePEc:kap:eurfin:v:8:y:2004:i:2:p:279-324
Contact details of provider: Web page: http://springerlink.metapress.com/link.asp?id=111870

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