Volatility Ambiguity, Consumption and Asset Prices

48 Pages Posted: 8 Feb 2020

See all articles by Yu Liu

Yu Liu

Tsinghua University

Hao Wang

Tsinghua University

Tan Wang

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Lihong Zhang

Tsinghua University - School of Economics & Management

Date Written: January 19, 2020

Abstract

We formulate a stylized model that admits volatility ambiguity to the Lucas framework. The model specifies an economically motivated ambiguity penalty function that makes volatility ambiguity quantifiable with χ2-statistics, and allows for analytical solutions. The addition of volatility ambiguity greatly expands the range of possible equilibrium outcomes of the Lucas model with the well documented empirical regularity being the equilibrium outcome of a range of sensible combination of parameters. The paper shows that while return volatilities are much easier to estimate than expected returns and therefore have lower ambiguity than the ambiguity in mean returns, it nonetheless plays an important role in the equilibrium determination of asset prices.

Keywords: Volatility ambiguity, ambiguity aversion, ambiguity index, ambiguity measure, ambiguity penalty

JEL Classification: G11, G12

Suggested Citation

Liu, Yu and Wang, Hao and Wang, Tan and Zhang, Lihong, Volatility Ambiguity, Consumption and Asset Prices (January 19, 2020). Available at SSRN: https://ssrn.com/abstract=3521872 or http://dx.doi.org/10.2139/ssrn.3521872

Yu Liu

Tsinghua University ( email )

Beijing, 100084
China
86 15210589482 (Phone)

Hao Wang (Contact Author)

Tsinghua University ( email )

318 Weilun Building
Tsinghua University
Beijing, 100084
China
86 10 62797482 (Phone)
86 10 62794554 (Fax)

Tan Wang

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Lihong Zhang

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

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