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Ambiguity on uncertainty and the equity premium

Xinfeng Ruan and Jin E. Zhang

Finance Research Letters, 2021, vol. 38, issue C

Abstract: This paper considers an asset pricing model with a multiple-priors recursive utility incorporating decision makers’ concern with ambiguity on drift and jumps of driving process. Based on our empirical evidence, given a small relative risk aversion (RRA) coefficient (e.g., RRA = 2), the model can well explain the equity premium puzzle, since the ambiguity aversion, as a complementary aversion of the risk aversion, can increase the equity premium and decrease the risk-free rate. This paper documents that ambiguity on uncertainty is a resolution of the equity premium puzzle.

Keywords: Ambiguity; Multiple priors; Equity premium puzzle (search for similar items in EconPapers)
JEL-codes: D53 D81 G12 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:38:y:2021:i:c:s1544612319312176

DOI: 10.1016/j.frl.2020.101429

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