Cross-sectional implications of dynamic asset pricing with stochastic volatility and ambiguity aversion

Rubén Lago-Balsalobre, Javier Rojo-Suárez and Ana B. Alonso-Conde

The North American Journal of Economics and Finance, 2023, vol. 66, issue C

Abstract: Building on recent research that highlights the importance of macroeconomic volatility and ambiguity aversion in explaining the dynamics of stock returns, in this paper we propose a dynamic asset pricing model that simultaneously accounts for stochastic macroeconomic volatility and ambiguity, assuming that investors deal with uncertainty about the mechanics of macroeconomic fluctuations using first-release consumption and revisions to aggregate consumption on vintage data. Our results show that the proposed model captures a large fraction of the cross-sectional variation of excess returns for a wide range of market anomaly portfolios. Furthermore, while the price of risk for ambiguity is positive and significant for the vast majority of assets under study, macroeconomic volatility yields ambiguous outcomes, although it significantly increases the explanatory power of the model for specific assets. Our results suggest that macroeconomic volatility and ambiguity complement each other in explaining the cross-sectional behavior of stock returns.

Keywords: Ambiguity; Macroeconomic volatility; Vintage consumption data; Dynamic asset pricing; Economic turmoil (search for similar items in EconPapers)
JEL-codes: G12 G15 (search for similar items in EconPapers)
Date: 2023
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:ecofin:v:66:y:2023:i:c:s1062940823000323

DOI: 10.1016/j.najef.2023.101909

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