Ambiguity Aversion and Variance Premium

Jianjun Miao, Bin Wei and Hao Zhou

No WP2012-009, Boston University - Department of Economics - Working Papers Series from Boston University - Department of Economics

Abstract: This paper offers an ambiguity-based interpretation of variance premium - the differ- ence between risk-neutral and objective expectations of market return variance - as a com- pounding effect of both belief distortion and variance differential regarding the uncertain economic regimes. Our approach endogenously generates variance premium without impos- ing exogenous stochastic volatility or jumps in consumption process. Such a framework can reasonably match the mean variance premium as well as the mean equity premium, equity volatility, and the mean risk-free rate in the data. We find that about 96 percent of the mean variance premium can be attributed to ambiguity aversion. Applying the model to historical consumption data, we find that variance premium mostly captures depressions, deep recessions, and financial panics, with a post war peak in 2009.

Keywords: Ambiguity aversion; learning; variance premium; regime-shift; belief distortion (search for similar items in EconPapers)
JEL-codes: D81 E44 G12 G13 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2012-01
New Economics Papers: this item is included in nep-mic and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (18)

Downloads: (external link)
http://people.bu.edu/miaoj/VRP18.pdf (application/pdf)

Related works:
Journal Article: Ambiguity Aversion and the Variance Premium (2019)
Working Paper: Ambiguity Aversion and Variance Premium (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:bos:wpaper:wp2012-009

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