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Ambiguity, risk and asset returns in continuous time

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Abstract

Existing models in stochastic continuous-time settings assume that beliefs are represented by a probability measure. As illustrated by the Ellsberg Paradox, this feature rules out a priori any concern with ambiguity. This paper formulates a continuous-time intertemporal version of multiple-priors utility, where aversion to ambiguity is admissible. When applied to a representative agent asset market setting, the model delivers restrictions on excess returns that admit interpretations reflecting a premium for risk and a seperate premium for ambiguity.

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  • Zengjing Chen & Larry G. Epstein, 2000. "Ambiguity, risk and asset returns in continuous time," RCER Working Papers 474, University of Rochester - Center for Economic Research (RCER).
  • Handle: RePEc:roc:rocher:474
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    File URL: http://rcer.econ.rochester.edu/RCERPAPERS/rcer_474.pdf
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    Keywords

    ambiguity; risk; continuous-time; asset returns; Knightian uncertainty; backward stochastic differential equation;

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D9 - Microeconomics - - Micro-Based Behavioral Economics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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