Ambiguity Aversion and Asset Price Dynamics
61 Pages Posted: 4 Oct 2016 Last revised: 14 Aug 2019
Date Written: August 13, 2019
We derive the equilibrium asset expected returns when there is ambiguity in asset expected returns, as well as ambiguity in asset return variances. In our model, ambiguity risk is systematic in nature and is non-diversifiable. Under regularity conditions, expected asset returns are linearly increasing in variance risk and ambiguity risk. We show that a beta pricing model can be derived from the equilibrium expected return function, which contains a systematic return factor and an ambiguity portfolio return factor, where the ambiguity portfolio weights are determined within the model. We test our model empirically and we obtain the model-implied results.
Keywords: Ambiguity aversion, Empirical asset pricing, Risk premium
JEL Classification: G11, G12
Suggested Citation: Suggested Citation