High Order Smooth Ambiguity Preferences and Asset Prices

41 Pages Posted: 25 Jan 2012 Last revised: 26 Nov 2017

See all articles by Julian Thimme

Julian Thimme

Karlsruhe Institute of Technology

Clemens Völkert

University of Muenster - Finance Center Muenster

Multiple version iconThere are 2 versions of this paper

Date Written: January 21, 2012

Abstract

This paper extends the recursive smooth ambiguity decision model developed in Klibanoff, Marinacci, and Mukerji (2005, 2009) by relaxing the uniformity imposed on higher order acts. This generalization permits a separation of intertemporal substitution, risk aversion, and ambiguity aversion towards different sources of uncertainty. Our decision model is suited in situations where subjects may treat several kinds of uncertainty in different manners. We apply our preference specification to a consumption-based asset pricing model with long-run risks and assess the impact of ambiguity on asset prices and predictability patterns. We find that modeling attitudes towards uncertainty through high order smooth ambiguity preferences has important implications for asset prices. Our model significantly improves upon the special cases of Epstein and Zin (1989) utility and standard smooth ambiguity preferences.

Keywords: Ambiguity aversion, asset pricing, long-run risks

JEL Classification: D81, E44, G12

Suggested Citation

Thimme, Julian and Völkert, Clemens, High Order Smooth Ambiguity Preferences and Asset Prices (January 21, 2012). Review of Financial Economics, Vol. 27, 2015. Available at SSRN: https://ssrn.com/abstract=1989518 or http://dx.doi.org/10.2139/ssrn.1989518

Julian Thimme

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

HOME PAGE: http://julianthimme.de

Clemens Völkert (Contact Author)

University of Muenster - Finance Center Muenster ( email )

Universitätsstr. 14-16
Münster, 48143
Germany

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