Learning and Asset Prices Under Ambiguous Information

Leippold, Markus; Trojani, Fabio; Vanini, Paolo

doi:10.1093/rfs/hhm035

Cited by 115 publications

(75 citation statements)

References 62 publications

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“…They require γ < 1 to explain the asset pricing puzzles. Embedding the multiplepriors model of Epstein and Schneider (2007) in a continuous-time framework, Leippold et al (2008) also assume ρ = γ < 1 as in Ju and Miao (2007). Unlike the present paper, they assume that (i) dividends are equal to consumption, (ii) dividend growth takes finitely many unknown values without regime shifts, and (iii) the agent receives an additional signal about dividends.…”

Section: Asset Pricingmentioning

confidence: 99%

“…Applying this learning model, Epstein and Schneider (2008) analyze asset pricing implications. Leippold et al (2008) embed this model in a continuous-time environment. In contrast to our paper, there is no distinction between risk aversion and intertemporal substitution and no separation between ambiguity and ambiguity attitudes in the preceding three papers.…”

Section: Introductionmentioning

confidence: 99%

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Ambiguity, Learning, and Asset Returns

2012

Econometrica

306

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We propose a novel generalized recursive smooth ambiguity model which allows a threeway separation among risk aversion, ambiguity aversion, and intertemporal substitution. We apply this utility to a consumption-based asset pricing model in which consumption and dividends follow hidden Markov regime-switching processes. Our calibrated model can match the mean equity premium, the mean riskfree rate, and the volatility of the equity premium observed in the data. In addition, our model can generate a variety of dynamic asset pricing phenomena, including the procyclical variation of price-dividend ratios, the countercyclical variation of equity premia and equity volatility, and the mean reversion of excess returns. The key intuition is that an ambiguity averse agent behaves pessimistically by attaching more weight to the pricing kernel in bad times when his continuation values are low.Keywords: Ambiguity aversion, learning, asset pricing puzzles, model uncertainty, robustness, pessimism JEL Classification: D81, E44, G12 * We thank Massimo Marinacci and Tom Sargent for encouragement, Lars Hansen, Hanno Lustig, Zhongjun Qu, Costis Skiadas (AFA discussant), Amir Yaron, and Stanley Zin (AEA discussant) for helpful comments. We are particularly grateful to Massimo Marinacci for his patient explanations of our questions. We have benefitted from comments from seminar participants in

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Section: Asset Pricingmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Ambiguity, Learning, and Asset Returns

2012

Econometrica

306

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“…Cao et al 2005;Ui 2011), equity premium and interest rate puzzles (e.g. Chen and Epstein 2002;Barillas et al 2009), excess volatility puzzle (Leippold et al 2008), home-bias puzzle (Epstein and Miao 2003;Uppal and Wang 2003) and American Options optimal exercise strategies (Riedel 2009). Asset pricing literature under ambiguity aversion has been comprehensively surveyed by Epstein and Schneider (2010).…”

Section: Introductionmentioning

confidence: 99%

The price of risk and ambiguity in an intertemporal general equilibrium model of asset prices

Faria

Correia‐da‐Silva²

2012

Ann Finance

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We consider a version of the intertemporal general equilibrium model of Cox et al. (Econometrica 53:363-384, 1985) with a single production process and two correlated state variables. It is assumed that only one of them, Y 2 , has shocks correlated with those of the economy's output rate and, simultaneously, that the representative agent is ambiguous about its stochastic process. This implies that changes in Y 2 should be hedged and its uncertainty priced, with this price containing risk and ambiguity components. Ambiguity impacts asset pricing through two channels: the price of uncertainty associated with the ambiguous state variable, Y 2 , and the interest rate. With ambiguity, the equilibrium price of uncertainty associated with Y 2 and the equilibrium interest rate can increase or decrease, depending on: (i) the correlations between the shocks in Y 2 and those in the output rate and in the other state variable; (ii) the diffusion functions of the stochastic processes for Y 2 and for the output rate; and (iii) the gradient of the value function with respect to Y 2 . As applications of our generic setting, we deduct the model of Longstaff and Schwartz (J Financ 47:1259(J Financ 47: -1282(J Financ 47: , 1992) for interest-rate-sensitive contingent claim pricing and the variance-risk price specification in the option pricing model of Heston (Rev Financ Stud 6:327-343, 1993). Additionally, it is obtained a variance-uncertainty price specification that can be used to obtain a closed-form solution for option pricing with ambiguity about stochastic variance.

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“…Recently, Leippold, Trojani, and Vanini (2008) have re-examined the effects of ambiguity on the equity premium and risk-free rate puzzles in a Lucas exchange economy with a constant relative risk aversion (CRRA) representative agent, who can invest in a single, risky security. Although their analysis is performed at a level of generality that is inferior to Epstein and Wang (1994) and Chen and Epstein (2002), their findings are insightful.…”

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confidence: 99%

Ambiguity in asset pricing and portfolio choice: a review of the literature

2012

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A growing body of empirical evidence suggests that investors' behavior is not well described by the traditional paradigm of (subjective) expected utility maximization under rational expectations. A literature has arisen that models agents whose choices are consistent with models that are less restrictive than the standard subjective expected utility framework. In this paper we conduct a survey of the existing literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. We conclude that the ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions, such as the empirical failure of the two-fund separation theorem in portfolio decisions, the modest exposure to risky securities observed for a majority of investors, the home equity preference in international portfolio diversification, the excess volatility of asset returns, the equity premium and the risk-free rate puzzles, and the occurrence of trading break-downs.JEL codes: G10, G18, D81.

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Learning and Asset Prices Under Ambiguous Information

Cited by 115 publications

References 62 publications

Ambiguity, Learning, and Asset Returns

Ambiguity, Learning, and Asset Returns

The price of risk and ambiguity in an intertemporal general equilibrium model of asset prices

Ambiguity in asset pricing and portfolio choice: a review of the literature

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