Asset Pricing under Smooth Ambiguity in Continuous Time

41 Pages Posted: 18 Mar 2022

See all articles by Lars Peter Hansen

Lars Peter Hansen

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Jianjun Miao

Boston University - Department of Economics

Date Written: March 1, 2022

Abstract

We study asset pricing implications of a revealing and tractable formulation of smooth ambiguity investor preferences in a continuous-time environment. Investors do not observe a hidden Markov state and instead make inferences about this state using past data. We show that ambiguity about this hidden state distribution alters investor decisions and equilibrium asset prices. Our continuous-time formulation allows us to apply recursive filtering and Hamilton-Jacobi-Bellman methods to solve the modified decision problem. Using such methods, we show how characterizations of portfolio allocations and local uncertainty-return tradeoffs change when investors are ambiguity-averse.

Keywords: Risk, ambiguity, robustness, asset pricing, portfolio allocation, continuous time

Suggested Citation

Hansen, Lars Peter and Miao, Jianjun, Asset Pricing under Smooth Ambiguity in Continuous Time (March 1, 2022). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2022-39, Available at SSRN: https://ssrn.com/abstract=4060271 or http://dx.doi.org/10.2139/ssrn.4060271

Lars Peter Hansen (Contact Author)

University of Chicago - Department of Economics ( email )

1101 E 58th ST
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National Bureau of Economic Research (NBER)

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Jianjun Miao

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States
617-353-6675 (Phone)

HOME PAGE: http://people.bu.edu/miaoj

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