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Ambiguity and the Historical Equity Premium

This paper assesses the quantitative impact of ambiguity on the historically observed financial asset returns and prices. The single agent, in a dynamic exchange economy, treats uncertainty about the conditional mean of the probability distribution on consumption and dividends in the next period as ambiguous, an ambiguity that is endogenously dynamic, e.g. , increasing during recessions. We calibrate ambiguity aversion to match only the first moment of the risk-free rate in data and, importantly, condition the uncertainty each period on the actually observed history of (U.S.) macroeconomic growth outcomes. We show the model implied time series of asset returnsmatch observed return dynamics very substantially

Sujoy Mukerji, University of Oxford
Fabrice Collard, University of Bern
Kevin Sheppard, University of Oxford
Jean-Marc Tallon, Université Paris 1
Publication Date: 
August, 2012
BFI Initiative: 
Publication Status: