Asset Pricing Theory in Light of Ellsberg Paradox

Abstract:     
In 2008, Epstein and Schneider formulated a microstructure-inspired theory in which one could determine price volatility through a number of other market parameters such as asset volatility, risk free rate and dividend rate. A particular feature of the Epstein-Schneider theory is an extremely high price elasticity of the volatility of a risky stock with respect to a risk-free rate. This conclusion begs for an empirical investigation. I use the specially filtered high-frequency returns on NASDAQ as proxy for the stock market and several possible proxies for the risk-free rate for an empirical test of the hypothesis.

Number of Pages in PDF File: 23

Keywords: Asymmetric Information, Volatility, Microstructure Noise

JEL Classification: G12, G14, G19

working papers series