Ambiguity and Information Processing in a Model of Intermediary Asset Pricing
44 Pages Posted: 3 Jun 2019 Last revised: 12 Jul 2019
Date Written: May 12, 2019
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: Suggested Citation