Asset Pricing under Knightian Uncertainty: A Case for Optimism

49 Pages Posted: 22 Dec 2021 Last revised: 3 Jul 2022

See all articles by Soroush Ghazi

Soroush Ghazi

University of Alabama - Department of Economics, Finance and Legal Studies

Mark Schneider

University of Alabama - Department of Economics, Finance and Legal Studies

Date Written: December 21, 2021

Abstract

We apply a representative agent model separating beliefs, Knightian uncertainty, and uncertainty attitude, to empirical puzzles for the aggregate stock market. Allowing for optimistic uncertainty attitudes helps match the risk-free rate, equity premium, variance risk premium, and risk-neutral entropy, and produces the observed pricing kernel U-shape. The low (high) persistence of market uncertainty (market optimism) generates return predictability of the price-dividend ratio, variance risk premium, market crash probability, and market correlation and helps explain short-run (long-run) dynamics of the pricing kernel. Accounting for the interaction of market volatility, uncertainty, and optimism helps identify the risk-return tradeoff for the aggregate market.

Keywords: Optimism, Uncertainty, Ambiguity, Skewness, NEO-EU CAPM, Stock Market Anomalies

JEL Classification: D8, G40, G41

Suggested Citation

Ghazi, Soroush and Schneider, Mark, Asset Pricing under Knightian Uncertainty: A Case for Optimism (December 21, 2021). Available at SSRN: https://ssrn.com/abstract=3990485 or http://dx.doi.org/10.2139/ssrn.3990485

Soroush Ghazi (Contact Author)

University of Alabama - Department of Economics, Finance and Legal Studies ( email )

P.O. Box 870244
Tuscaloosa, AL 35487
United States

HOME PAGE: http://sites.google.com/view/soroush-ghazi

Mark Schneider

University of Alabama - Department of Economics, Finance and Legal Studies ( email )

361 Stadium Dr, Ste 200
Tuscaloosa, AL 35487
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
80
Abstract Views
339
rank
421,625
PlumX Metrics