The Risk-Neutral Equivalent Pricing of Model-Uncertainty

Ken Kangda Wren

Papers from arXiv.org

Abstract: Existing approaches to asset-pricing under model-uncertainty adapt classical utility-maximization frameworks and seek theoretical comprehensiveness. We move toward practice by considering binary model-uncertainties and by switching attention from 'preference' to 'constraints'. This decomposes economic asset-pricing into the viable pricing of model-risk and non-model risk separately such that the former has a unique and intuitive formula with convenient properties. Its parameter, dynamically conserved under model-risk inference, allows an integrated representation of ex-ante risk-pricing and bias, with ex-post price-effects that can be disentangled, through well-known anomalies, Momentum and Low-Risk, whose risk-reward curves acquire a new significance: peak-rewards measure ex-ante risk-pricing, and peak-locations, bias.

Date: 2025-02, Revised 2025-04
New Economics Papers: this item is included in nep-upt
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