Financial Uncertainty with Ambiguity and Learning

Hening Liu () and Yuzhao Zhang ()
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Hening Liu: Alliance Manchester Business School, University of Manchester, Manchester M15 6PB, United Kingdom
Yuzhao Zhang: Rutgers Business School, Rutgers, The State University of New Jersey, Newark, New Jersey 07102

Management Science, 2022, vol. 68, issue 3, 2120-2140

Abstract: We examine a production-based asset pricing model with regime-switching productivity growth, learning, and ambiguity. Both the mean and volatility of the growth rate of productivity are assumed to follow a Markov chain with an unobservable state. The agent’s preferences are characterized by the generalized recursive smooth ambiguity utility function. Our calibrated benchmark model with modest risk aversion can match moments of the variance risk premium in the data and reconcile empirical relations between the risk-neutral variance and macroeconomic quantities and their respective volatilities. We show that the interplay between productivity volatility risk and ambiguity aversion is important for pricing variance risk in returns.

Keywords: ambiguity; business cycle; Markov switching; production-based asset pricing; uncertainty; variance risk premium (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:68:y:2022:i:3:p:2120-2140

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