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Ambiguity, Information Quality and Asset Pricing

When ambiguity averse investors process news of uncertain quality, they act as if they take a worst-case assessment of quality. As a result, they react more strongly to bad news than to good news. They also dislike assets for which information quality is poor, especially when the underlying fundamentals are volatile. These effects induce negative skewness in asset returns, increase price volatility and induce ambiguity premia that depend on idiosyncratic risk in fundamentals. Moreover, shocks to information quality can have persistent negative effects on prices even if fundamentals do not change. This helps to explain the reaction of markets to events like 9/11/2001.

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File URL: http://rcer.econ.rochester.edu/RCERPAPERS/rcer_507.pdf
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Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number 507.

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Length: 33 pages
Date of creation: May 2004
Date of revision:
Handle: RePEc:roc:rocher:507
Contact details of provider: Postal: University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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