Ambiguity and Volatility

Asset Pricing Implications

B. Pataracchia

Research output: Working paperDiscussion paperOther research output

287 Downloads (Pure)

Abstract

Using a simple dynamic consumption-based asset pricing model, this paper explores the implications of a representative investor with smooth ambiguity averse preferences [Klibano¤, Marinacci and Mukerji, Econometrica (2005)] and provides a comparative analysis of risk aversion and ambiguity aversion. The perception of ambiguity is described by a hidden Markovian consumption growth process. The hidden states di¤er both for the mean and the volatility. We show that the ambiguity-averse investor downweights high-mean states in favor of low-mean ones. However, such distortion appears much stronger in low-volatility regimes: high volatility attenuates the distortion due to ambiguity concerns. It follows that (i) ambiguity aversion always implies higher equity premia but sustained levels of ambiguity aversion do not help explaining the high volatility of the equity premium observed in the data (volatility puzzle); (ii) our calibrated model can match the moments of the equity premium and risk free rate and can generate asset-price stylized facts like a procyclical price-dividend ratio and countercyclical conditional equity premia; however, (iii) high levels of ambiguity aversion, necessary to explain high equity returns, produce counterfactual price-dividend ratio time series across volatility states.
Original languageEnglish
Place of PublicationTilburg
PublisherEconometrics
Volume2011-042
Publication statusPublished - 2011

Publication series

NameCentER Discussion Paper
Volume2011-042

Fingerprint

Asset pricing
Ambiguity aversion
Equity
Investors
Equity premium
Dividends
Equity returns
Risk-free rate
Consumption-based asset pricing
Asset pricing models
Stylized facts
Asset prices
Risk aversion
Equity risk
Consumption growth
Comparative analysis

Keywords

  • Ambiguity aversion
  • volatility
  • asset pricing puzzles
  • robustness

Cite this

Pataracchia, B. (2011). Ambiguity and Volatility: Asset Pricing Implications. (CentER Discussion Paper; Vol. 2011-042). Tilburg: Econometrics.
Pataracchia, B. / Ambiguity and Volatility : Asset Pricing Implications. Tilburg : Econometrics, 2011. (CentER Discussion Paper).
@techreport{78d5fd618874444a84ea3c26618e00a3,
title = "Ambiguity and Volatility: Asset Pricing Implications",
abstract = "Using a simple dynamic consumption-based asset pricing model, this paper explores the implications of a representative investor with smooth ambiguity averse preferences [Klibano¤, Marinacci and Mukerji, Econometrica (2005)] and provides a comparative analysis of risk aversion and ambiguity aversion. The perception of ambiguity is described by a hidden Markovian consumption growth process. The hidden states di¤er both for the mean and the volatility. We show that the ambiguity-averse investor downweights high-mean states in favor of low-mean ones. However, such distortion appears much stronger in low-volatility regimes: high volatility attenuates the distortion due to ambiguity concerns. It follows that (i) ambiguity aversion always implies higher equity premia but sustained levels of ambiguity aversion do not help explaining the high volatility of the equity premium observed in the data (volatility puzzle); (ii) our calibrated model can match the moments of the equity premium and risk free rate and can generate asset-price stylized facts like a procyclical price-dividend ratio and countercyclical conditional equity premia; however, (iii) high levels of ambiguity aversion, necessary to explain high equity returns, produce counterfactual price-dividend ratio time series across volatility states.",
keywords = "Ambiguity aversion, volatility, asset pricing puzzles, robustness",
author = "B. Pataracchia",
year = "2011",
language = "English",
volume = "2011-042",
series = "CentER Discussion Paper",
publisher = "Econometrics",
type = "WorkingPaper",
institution = "Econometrics",

}

Pataracchia, B 2011 'Ambiguity and Volatility: Asset Pricing Implications' CentER Discussion Paper, vol. 2011-042, Econometrics, Tilburg.

Ambiguity and Volatility : Asset Pricing Implications. / Pataracchia, B.

Tilburg : Econometrics, 2011. (CentER Discussion Paper; Vol. 2011-042).

Research output: Working paperDiscussion paperOther research output

TY - UNPB

T1 - Ambiguity and Volatility

T2 - Asset Pricing Implications

AU - Pataracchia, B.

PY - 2011

Y1 - 2011

N2 - Using a simple dynamic consumption-based asset pricing model, this paper explores the implications of a representative investor with smooth ambiguity averse preferences [Klibano¤, Marinacci and Mukerji, Econometrica (2005)] and provides a comparative analysis of risk aversion and ambiguity aversion. The perception of ambiguity is described by a hidden Markovian consumption growth process. The hidden states di¤er both for the mean and the volatility. We show that the ambiguity-averse investor downweights high-mean states in favor of low-mean ones. However, such distortion appears much stronger in low-volatility regimes: high volatility attenuates the distortion due to ambiguity concerns. It follows that (i) ambiguity aversion always implies higher equity premia but sustained levels of ambiguity aversion do not help explaining the high volatility of the equity premium observed in the data (volatility puzzle); (ii) our calibrated model can match the moments of the equity premium and risk free rate and can generate asset-price stylized facts like a procyclical price-dividend ratio and countercyclical conditional equity premia; however, (iii) high levels of ambiguity aversion, necessary to explain high equity returns, produce counterfactual price-dividend ratio time series across volatility states.

AB - Using a simple dynamic consumption-based asset pricing model, this paper explores the implications of a representative investor with smooth ambiguity averse preferences [Klibano¤, Marinacci and Mukerji, Econometrica (2005)] and provides a comparative analysis of risk aversion and ambiguity aversion. The perception of ambiguity is described by a hidden Markovian consumption growth process. The hidden states di¤er both for the mean and the volatility. We show that the ambiguity-averse investor downweights high-mean states in favor of low-mean ones. However, such distortion appears much stronger in low-volatility regimes: high volatility attenuates the distortion due to ambiguity concerns. It follows that (i) ambiguity aversion always implies higher equity premia but sustained levels of ambiguity aversion do not help explaining the high volatility of the equity premium observed in the data (volatility puzzle); (ii) our calibrated model can match the moments of the equity premium and risk free rate and can generate asset-price stylized facts like a procyclical price-dividend ratio and countercyclical conditional equity premia; however, (iii) high levels of ambiguity aversion, necessary to explain high equity returns, produce counterfactual price-dividend ratio time series across volatility states.

KW - Ambiguity aversion

KW - volatility

KW - asset pricing puzzles

KW - robustness

M3 - Discussion paper

VL - 2011-042

T3 - CentER Discussion Paper

BT - Ambiguity and Volatility

PB - Econometrics

CY - Tilburg

ER -

Pataracchia B. Ambiguity and Volatility: Asset Pricing Implications. Tilburg: Econometrics. 2011. (CentER Discussion Paper).