Asset Pricing with Ambiguous Signals: An Experiment

Abstract

This paper explores how ambiguous signals and ambiguity aversion influence individuals' expectations and the pricing of asset in experimental financial markets. In line with the theory of Epstein and Schneider (2008) we find that subjects' degree of ambiguity aversion is positively correlated with their expectations about the variance of ambiguous signals. These signals matter for the determination of asset prices. We find that the distribution of the excess return of the asset exhibits negative skewness, and that price volatility is significantly larger under ambiguous signals. Our findings provide evidence in support of the idea that ambiguous information and ambiguity aversion may be a source of negative skewness and excess volatility in financial markets.

Keywords: Ambiguity Aversion, Asset Bubbles, Experimental Finance, Signal Extraction, Negative Skewness

JEL Classification: C91, C92, D82, G12, G40