The Price of Uncertainty in the Term Structure of Equity and Treasury Yields

Abstract

I propose a consumption-based asset pricing model in which the decision maker prices U.S. Treasury zero-coupon bonds and dividend cash flows on the aggregate S&P 500 index with maturities up to 30 years. The decision maker does not know the objective probability generating the data, and she evaluates a set of models that is twisted to include structured parametric alternatives. I set up a state-space with macroeconomic and aggregate financial variables to measure how the market price of (model) uncertainty contributes to the short and long-run payoff valuation. My analysis replicates prominent features of the data for both asset classes.

Keywords: Asset prices, Uncertainty, Robustness, Risk, Relative entropy

JEL Classification: C52, C58, D81, D84, G12