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Unawareness Premia

Author

Listed:
  • Scott Condie

    (Department of Economics, Brigham Young University)

  • Lars Stentoft

    (Department of Economics and Department of Actuarial and Statistical Sciences, Western University)

  • Marie-Louise Vierø

    (Department of Economics and Business Economics, Aarhus University)

Abstract

This paper considers the effect on asset prices of investors contemplating the possible occurrence of unexpected and unprecedented events that they have no basis to evaluate. We build a Capital Asset Pricing Model (CAPM) where, in addition to regular risk, investors are aware that they are potentially unaware of some events. We show that when investors feel that there exist states about which they are unaware, asset prices contain an unawareness premium. A driving force is that the “risk free†asset is no longer considered to be truly risk free. We develop a methodology that enables us to estimate the systematic portion of the unawareness premium, and we estimate it using data from 1980 to 2022. We find evidence in support of the hypothesis that unawareness, in addition to risk, is a determinant of expected equity returns.

Suggested Citation

  • Scott Condie & Lars Stentoft & Marie-Louise Vierø, 2023. "Unawareness Premia," Economics Working Papers 2023-09, Department of Economics and Business Economics, Aarhus University.
    • Handle: RePEc:aah:aarhec:2023-09
    as

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    References listed on IDEAS

    as
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    More about this item

    Keywords

    CAPM; Equity Premium; Unawareness;
    All these keywords.

    JEL classification:

    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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