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Ambiguity Aversion and Asset Prices in Production Economies

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  • Mohammad R. Jahan-Parvar
  • Hening Liu

Abstract

We examine a production-based asset-pricing model with an unobservable mean growth rate following a two-state Markov chain and with an ambiguity-averse representative agent. Our model requires a low coefficient of relative risk aversion to produce: (i) a high equity premium and volatile equity returns, (ii) a low and smooth risk-free rate, (iii) smooth consumption growth and volatile investment growth, (iv) countercyclical equity premium and market price of risk, (v) conditional heteroscedasticity in returns, and (vi) long-horizon predictability of excess returns.

Suggested Citation

  • Mohammad R. Jahan-Parvar & Hening Liu, 2014. "Ambiguity Aversion and Asset Prices in Production Economies," Review of Financial Studies, Society for Financial Studies, vol. 27(10), pages 3060-3097.
  • Handle: RePEc:oup:rfinst:v:27:y:2014:i:10:p:3060-3097.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhu037
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    Cited by:

    1. Gallant, A. Ronald & Jahan-Parvar, Mohammad & Liu, Hening, 2015. "Measuring Ambiguity Aversion," Finance and Economics Discussion Series 2015-105, Board of Governors of the Federal Reserve System (US).
    2. Massimo Marinacci, 2015. "Model Uncertainty," Journal of the European Economic Association, European Economic Association, vol. 13(6), pages 1022-1100, December.
    3. Backus, David & Ferriere, Axelle & Zin, Stanley, 2015. "Risk and ambiguity in models of business cycles," Journal of Monetary Economics, Elsevier, vol. 69(C), pages 42-63.
    4. Martin Schneider & Cosmin Ilut & Francesco Bianchi, 2013. "Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle," 2013 Meeting Papers 202, Society for Economic Dynamics.

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