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Ambiguity and the historical equity premium

  • Fabrice Collard

    ()

    (Department of Economics - University of Bern)

  • Sujoy Mukerji

    ()

    (Department of Economics and University College - University of Oxford)

  • Kevin Sheppard

    ()

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

  • Jean-Marc Tallon

    ()

    (Centre d'Economie de la Sorbonne - Paris School of Economics)

This paper assesses the quantitative impact of ambiguity on the historically observed financial asset returns and prices. The single agent, in a dynamic exchange economy, treats uncertainty about the conditional mean of the probability distribution on consumption and dividends in the next period as ambiguous, an ambiguity that is endogenously dynamic, e.g., increasing during recessions. We calibrate ambiguity aversion to match only the first moment of the risk-free rate in data and, importantly, the (conditional) ambiguity to match the uncertainty conditional on the actual history of macroeconomic growth outcomes. The model matches observed asset return dynamics very substantially.

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File URL: ftp://mse.univ-paris1.fr/pub/mse/CES2011/11032R.pdf
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Paper provided by Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne in its series Documents de travail du Centre d'Economie de la Sorbonne with number 11032r.

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Length: 57 pages
Date of creation: May 2011
Date of revision: Aug 2012
Handle: RePEc:mse:cesdoc:11032r
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