Ambiguity premium and transaction costs

Bong-Gyu Jang, Taeyoon Kim, Seungkyu Lee and Seyoung Park

Economics Letters, 2021, vol. 207, issue C

Abstract: We generalize the optimal investment model of an ambiguity averse investor with transaction costs. Along the lines of Maenhout (2004), we first show that ambiguity (or model uncertainty) leads to an increase in effective risk aversion by ambiguity aversion even with transaction costs. We compute the utility cost associated with suboptimal investment decisions, which is the so-called ambiguity premium. We then find that ignoring ambiguity aversion with and without transaction costs generates large ambiguity premia when ambiguity aversion is moderate, and the cost of ignoring it becomes larger with higher ambiguity aversion. This would, thus, still support the importance of ambiguity aversion channel for portfolio choice, even concerning the friction markets.

Keywords: Optimal investment; Ambiguity aversion; Transaction costs; Ambiguity premium (search for similar items in EconPapers)
JEL-codes: C61 E21 G11 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:207:y:2021:i:c:s0165176521002846

DOI: 10.1016/j.econlet.2021.110007

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