A simple robust asset pricing model under statistical ambiguity

Luis Garcia-Feijoo and Ariel Viale

Quantitative Finance, 2022, vol. 22, issue 5, 861-869

Abstract: We derive a simple robust single-factor market model under statistical ambiguity that uses relative entropy as the ambiguity index constraining the multiple priors set. We also discuss theoretically the validity of relative entropy to measure model discrepancy and detect misspecification. The premium on both risk and ambiguity in our model would set a bound on stock prices that investors can use as a ‘margin of safety’ against extreme market events.

Date: 2022
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DOI: 10.1080/14697688.2021.2020887

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