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Ambiguity and the historical equity premium

Author

Listed:
  • Fabrice Collard

    (TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique)

  • Sujoy Mukerji

    (School of Economics and Finance, Queen Mary, University of London - QMUL - School of Economics and Finance - QMUL - Queen Mary University of London)

  • Kevin Sheppard

    (Department of Economics and Oxford-Man Institute of Quantitative Finance - University of Oxford)

  • Jean-Marc Tallon

    (PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique)

Abstract

This paper assesses the quantitative impact of ambiguity on historically observed financial asset returns and growth rates. The single agent, in a dynamic exchange economy, treats the conditional uncertainty about the consumption and dividends next period as ambiguous. We calibrate the agent's ambiguity aversion to match only the first moment of the risk‐free rate in data and measure the uncertainty each period conditional on the actual, observed history of (U.S.) macroeconomic growth outcomes. Ambiguity aversion accentuates the effect of conditional uncertainty endogenously in a dynamic way, depending on the history; for example, it increases during recessions. We show the model implied time series of asset returns substantially match the first and second conditional moments of observed return dynamics. In particular, we find the time‐series properties of our model generated equity premium, which may be regarded as an index measure of revealed uncertainty, relates closely to those of the macroeconomic uncertainty indices developed recently in Jurado, Ludvigson, and Ng, 2015 and Carriero, Clark, and Marcellino, forthcoming.

Suggested Citation

  • Fabrice Collard & Sujoy Mukerji & Kevin Sheppard & Jean-Marc Tallon, 2018. "Ambiguity and the historical equity premium," PSE-Ecole d'économie de Paris (Postprint) halshs-01886571, HAL.
  • Handle: RePEc:hal:pseptp:halshs-01886571
    DOI: 10.3982/QE708
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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