Ambiguous volatility and asset pricing in continuous time

Larry Epstein and Shaolin Ji

Papers from arXiv.org

Abstract: This paper formulates a model of utility for a continuous time framework that captures the decision-maker's concern with ambiguity about both volatility and drift. Corresponding extensions of some basic results in asset pricing theory are presented. First, we derive arbitrage-free pricing rules based on hedging arguments. Ambiguous volatility implies market incompleteness that rules out perfect hedging. Consequently, hedging arguments determine prices only up to intervals. However, sharper predictions can be obtained by assuming preference maximization and equilibrium. Thus we apply the model of utility to a representative agent endowment economy to study equilibrium asset returns. A version of the C-CAPM is derived and the effects of ambiguous volatility are described.

Date: 2013-01
New Economics Papers: this item is included in nep-mic and nep-upt
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Citations: View citations in EconPapers (88)

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http://arxiv.org/pdf/1301.4614 Latest version (application/pdf)

Related works:
Journal Article: Ambiguous Volatility and Asset Pricing in Continuous Time (2013)
Working Paper: Ambiguous Volatility and Asset Pricing in Continuous Time (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1301.4614

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