Learning about the persistence of recessions under ambiguity aversion

Liu Liu

Finance Research Letters, 2022, vol. 47, issue PA

Abstract: The equity premium increased greatly in the Great Recession and the COVID-19 recession. To explain the magnitude of the increase, this paper proposes a theoretical model where the representative investor is ambiguity averse towards the uncertainty over the persistence of recessions. Results show that ambiguity aversion, as opposed to risk aversion, is the key ingredient to match the sharp increase in the equity premium. Specifically, the effect of ambiguity aversion on the equity premium is asymmetric across economic expansions and recessions. By contrast, an increase in risk aversion results in weaker countercyclical variation in the equity premium.

Keywords: Equity premium; Ambiguity aversion; Learning; Regime switching (search for similar items in EconPapers)
JEL-codes: D81 D83 E32 G12 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:47:y:2022:i:pa:s154461232100489x

DOI: 10.1016/j.frl.2021.102522

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