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

See all articles by Mohammad R. Jahan-Parvar

Mohammad R. Jahan-Parvar

Board of Governors of the Federal Reserve System

Hening Liu

University of Manchester - Alliance Manchester Business School

Date Written: April 11, 2014

Abstract

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

Jahan-Parvar, Mohammad R. and Liu, Hening, Ambiguity Aversion and Asset Prices in Production Economies (April 11, 2014). The Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2012740 or http://dx.doi.org/10.2139/ssrn.2012740

Mohammad R. Jahan-Parvar (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://sites.google.com/site/mrjahan/

Hening Liu

University of Manchester - Alliance Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

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