IDEAS home Printed from https://ideas.repec.org/p/mse/cesdoc/11032rrr.html
   My bibliography  Save this paper

Ambiguity and the historical equity premium

Author

Listed:
  • 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

    () (Paris School of Economics)

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 on the actual, observed history of (U.S.) macroeconomic growth outcomes. Ambiguity aversion accentuates the conditional uncertainty endogenously in a dynamic way, depending on the history; e.g., 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 index recently developed in Jurado, Ludvigson, and Ng (2013)

Suggested Citation

  • Fabrice Collard & Sujoy Mukerji & Kevin Sheppard & Jean-Marc Tallon, 2011. "Ambiguity and the historical equity premium," Documents de travail du Centre d'Economie de la Sorbonne 11032rrr, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne, revised Apr 2016.
  • Handle: RePEc:mse:cesdoc:11032rrr
    as

    Download full text from publisher

    File URL: ftp://mse.univ-paris1.fr/pub/mse/CES2011/11032RRR.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Lars Peter Hansen, 2007. "Beliefs, Doubts and Learning: Valuing Macroeconomic Risk," American Economic Review, American Economic Association, vol. 97(2), pages 1-30, May.
    2. Fabio Maccheroni & Massimo Marinacci & Doriana Ruffino, 2013. "Alpha as Ambiguity: Robust Mean‐Variance Portfolio Analysis," Econometrica, Econometric Society, vol. 81(3), pages 1075-1113, May.
    3. Larry G. Epstein, 2010. "A Paradox for the “Smooth Ambiguity” Model of Preference," Econometrica, Econometric Society, vol. 78(6), pages 2085-2099, November.
    4. Jouini, Elyes & Napp, Clotilde, 2006. "Heterogeneous beliefs and asset pricing in discrete time: An analysis of pessimism and doubt," Journal of Economic Dynamics and Control, Elsevier, vol. 30(7), pages 1233-1260, July.
    5. Fernández-Villaverde, Jesús & Rubio-Ramírez, Juan Francisco, 2010. "Macroeconomics and Volatility: Data, Models, and Estimation," CEPR Discussion Papers 8169, C.E.P.R. Discussion Papers.
    6. Larry G. Epstein & Martin Schneider, 2008. "Ambiguity, Information Quality, and Asset Pricing," Journal of Finance, American Finance Association, vol. 63(1), pages 197-228, February.
    7. Aart Kraay & Jaume Ventura, 2007. "The Dot-Com Bubble, the Bush Deficits, and the U.S. Current Account," NBER Chapters,in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 457-496 National Bureau of Economic Research, Inc.
    8. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, August.
    9. Hui Chen & Nengjiu Ju & Jianjun Miao, 2014. "Dynamic Asset Allocation with Ambiguous Return Predictability," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(4), pages 799-823, October.
    10. John Y. Campbell, 2000. "Asset Pricing at the Millennium," Journal of Finance, American Finance Association, vol. 55(4), pages 1515-1567, August.
    11. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, May.
    12. Lars Peter Hansen & Thomas J. Sargent, 2010. "Fragile beliefs and the price of uncertainty," Quantitative Economics, Econometric Society, vol. 1(1), pages 129-162, July.
    13. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
    14. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
    15. 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 (U.S.).
    16. Nengjiu Ju & Jianjun Miao, 2012. "Ambiguity, Learning, and Asset Returns," Econometrica, Econometric Society, vol. 80(2), pages 559-591, March.
    17. Lars Peter Hansen, 2007. "Beliefs, Doubts and Learning: Valuing Economic Risk," NBER Working Papers 12948, National Bureau of Economic Research, Inc.
    18. Sujoy Mukerji & Jean-Marc Tallon, 2001. "Ambiguity Aversion and Incompleteness of Financial Markets," Review of Economic Studies, Oxford University Press, vol. 68(4), pages 883-904.
    19. Christian Gollier, 2011. "Portfolio Choices and Asset Prices: The Comparative Statics of Ambiguity Aversion," Review of Economic Studies, Oxford University Press, vol. 78(4), pages 1329-1344.
    20. Beeler, Jason & Campbell, John Y., 2012. "The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment," Critical Finance Review, now publishers, vol. 1(1), pages 141-182, January.
    21. Fatih Guvenen, 2009. "A Parsimonious Macroeconomic Model for Asset Pricing," Econometrica, Econometric Society, vol. 77(6), pages 1711-1750, November.
    22. Uhlig, Harald, 2010. "A model of a systemic bank run," Journal of Monetary Economics, Elsevier, vol. 57(1), pages 78-96, January.
    23. Tomasz Strzalecki, 2013. "Temporal Resolution of Uncertainty and Recursive Models of Ambiguity Aversion," Econometrica, Econometric Society, vol. 81(3), pages 1039-1074, May.
    24. repec:dau:papers:123456789/341 is not listed on IDEAS
    25. Morten O. Ravn & Harald Uhlig, 2002. "On adjusting the Hodrick-Prescott filter for the frequency of observations," The Review of Economics and Statistics, MIT Press, vol. 84(2), pages 371-375.
    26. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
    27. Veronesi, Pietro, 1999. "Stock Market Overreaction to Bad News in Good Times: A Rational Expectations Equilibrium Model," Review of Financial Studies, Society for Financial Studies, vol. 12(5), pages 975-1007.
    28. Ravi Bansal & A. Ronald Gallant & George Tauchen, 2007. "Rational Pessimism, Rational Exuberance, and Asset Pricing Models," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1005-1033.
    29. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
    30. Robert J. Barro, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," The Quarterly Journal of Economics, Oxford University Press, vol. 121(3), pages 823-866.
    31. Peter Klibanoff & Massimo Marinacci & Sujoy Mukerji, 2005. "A Smooth Model of Decision Making under Ambiguity," Econometrica, Econometric Society, vol. 73(6), pages 1849-1892, November.
    32. Dow, James & Werlang, Sergio Ribeiro da Costa, 1992. "Uncertainty Aversion, Risk Aversion, and the Optimal Choice of Portfolio," Econometrica, Econometric Society, vol. 60(1), pages 197-204, January.
    33. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-969, July.
    34. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March.
    35. Schmeidler, David, 1989. "Subjective Probability and Expected Utility without Additivity," Econometrica, Econometric Society, vol. 57(3), pages 571-587, May.
    36. Martin L. Weitzman, 2007. "Subjective Expectations and Asset-Return Puzzles," American Economic Review, American Economic Association, vol. 97(4), pages 1102-1130, September.
    37. Giordani, Paolo & Soderlind, Paul, 2006. "Is there evidence of pessimism and doubt in subjective distributions? Implications for the equity premium puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 30(6), pages 1027-1043, June.
    38. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
    39. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January.
    40. Abel, Andrew B., 1999. "Risk premia and term premia in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 3-33, February.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Equity premium; ambiguity;

    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:mse:cesdoc:11032rrr. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lucie Label). General contact details of provider: http://edirc.repec.org/data/cenp1fr.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.