Ambiguity Aversion and Asset Price Dynamics

61 Pages Posted: 4 Oct 2016 Last revised: 14 Aug 2019

See all articles by Louis R. Piccotti

Louis R. Piccotti

Oklahoma State University - Stillwater - Spears School of Business

Yangru Wu

Rutgers University, Newark - School of Business - Department of Finance & Economics

Date Written: August 13, 2019

Abstract

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

Piccotti, Louis R. and Wu, Yangru, Ambiguity Aversion and Asset Price Dynamics (August 13, 2019). Available at SSRN: https://ssrn.com/abstract=2847424 or http://dx.doi.org/10.2139/ssrn.2847424

Louis R. Piccotti (Contact Author)

Oklahoma State University - Stillwater - Spears School of Business ( email )

460 Business
Stillwater, OK 74078-0555
United States

Yangru Wu

Rutgers University, Newark - School of Business - Department of Finance & Economics ( email )

1 Washington Park
Newark, NJ 07102
United States
973-353-1146 (Phone)
973-353-1006 (Fax)

HOME PAGE: http://andromeda.rutgers.edu/~yangruwu

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