Ambiguity Aversion and Asset Prices in Production Economies
The Review of Financial Studies, Forthcoming
47 Pages Posted: 29 Feb 2012 Last revised: 13 May 2014
Date Written: April 11, 2014
We examine a production-based asset pricing model with an unobservable mean growth rate ollowing a two-state Markov chain and with an ambiguity averse representative agent. Our model requires a low coefficient of relative risk aversion to produce: (i) a high equity premium and volatile equity returns, (ii) a low and smooth risk-free rate, (iii) smooth consumption growth and volatile nvestment growth, (iv) countercyclical equity premium and market price of risk, (v) conditional heteroscedasticity in returns, and (vi) long-horizon predictability of excess returns.
Keywords: Ambiguity aversion, Equity premium, Markov switching, Production economy, Smooth ambiguity
JEL Classification: C61, D81, G11, G12
Suggested Citation: Suggested Citation