Ambiguity, Long-Run Risks, and Asset Prices

61 Pages Posted: 2 Jan 2019

See all articles by Bin Wei

Bin Wei

Federal Reserve Bank of Atlanta

Date Written: December 15, 2018


We generalize the long-run risks (LRR) model in Bansal and Yaron (2004) by incorporating the recursive smooth ambiguity aversion preferences of Klibanoff, Marinacci, and Mukerji (2005, 2009) and time-varying ambiguity. Relative to the Bansal-Yaron model, the generalized LRR model remains tractable and is more flexible due to the separation of ambiguity aversion from risk aversion and the intertemporal elasticity of substitution. The three-way separation allows the model to further account for the variance premium puzzle, besides the puzzles of the equity premium, the risk-free rate, and the return predictability. Specifically, the model matches reasonably well key asset pricing moments with risk aversion under 5. By calibration we show that the ambiguity aversion channel accounts for 77 percent of the variance premium, and 40 percent of the equity premium.

Keywords: smooth ambiguity aversion, long-run risks, equity premium puzzle, risk-free rate puzzle, variance premium puzzle, return predictability

JEL Classification: G12, G13, D81, E44

Suggested Citation

Wei, Bin, Ambiguity, Long-Run Risks, and Asset Prices (December 15, 2018). Available at SSRN: or

Bin Wei (Contact Author)

Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

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