Ambiguity and Information Processing in a Model of Intermediary Asset Pricing

44 Pages Posted: 3 Jun 2019 Last revised: 12 Jul 2019

See all articles by Leyla Jianyu Han

Leyla Jianyu Han

University of Hong Kong

Kenneth Kasa

Simon Fraser University (SFU) - Department of Economics

Yulei Luo

University of Hong Kong

Date Written: May 12, 2019

Abstract

This paper incorporates ambiguity and information processing constraints into a model of intermediary asset pricing. Financial intermediaries are assumed to possess greater information processing capacity. Households purchase this capacity, and then delegate their investment decisions to intermediaries. As in He and Krishnamurthy (2012), the delegation contract is constrained by a moral hazard problem, which gives rise to a minimum capital requirement. Both agents have a preference for robustness, reflecting ambiguity about asset returns. We show that ambiguity aversion tightens the capital constraint, and amplifies its effects.

Indirect inference is used to calibrate the model’s parameters to the stochastic properties of asset returns. Detection error probabilities are used to discipline the degree of ambiguity aversion. The model can explain both the unconditional moments of asset returns and their state dependence, even with DEPs in excess of 20%.

Keywords: Ambiguity, Information Processing, Asset Pricing, Financial Crisis

JEL Classification: D81, G01, G12

Suggested Citation

Han, Leyla Jianyu and Kasa, Kenneth and Luo, Yulei, Ambiguity and Information Processing in a Model of Intermediary Asset Pricing (May 12, 2019). Available at SSRN: https://ssrn.com/abstract=3386888 or http://dx.doi.org/10.2139/ssrn.3386888

Leyla Jianyu Han (Contact Author)

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Hong Kong
Hong Kong

Kenneth Kasa

Simon Fraser University (SFU) - Department of Economics ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

Yulei Luo

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, HK
China

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