The Role of Aggregate Risk Aversion in the Pricing of Economic Uncertainty

Abstract

We find that time-varying aggregate risk aversion is a vital state variable to the pricing of economic uncertainty documented by Bali et al. (2017). Economic uncertainty is priced only during periods with a high aggregate risk aversion level. Risk aversion related component in economic uncertainty contributes the major proportion of uncertainty premium. This proportion fluctuates with real economy, whereas the remaining varies with market sentiment. Uncertainty premium is most prominent following periods simultaneously having high aggregate risk aversion and high economic uncertainty.

Keywords: Risk aversion, Economic uncertainty, Asset pricing, Anomalies, Sentiment

JEL Classification: G12, G14