Ambiguity and Time-Varying Risk Aversion in Sovereign Debt Markets
Christoph Große Steffen and
No 1602, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research
This paper introduces changes in the level of ambiguity as a complementary source of time-varying risk aversion. We show in a consumption-based asset pricing model with simultaneously risky and ambiguous assets that a rise in the level of ambiguity raises investors' risk aversion. The effect is quantified in an application to European sovereign debt markets using a structural VAR to achieve identification in the data. We proxy for ambiguity using a measure of macroeconomic uncertainty and decompose empirically credit default swaps (CDS) for Spain and Italy into three shocks: fundamental default risk, risk aversion, and uncertainty. We find that shocks to uncertainty significantly increase international investors' risk aversion, accounting for about one fifth of its variation at a five week horizon, and have a significant and economically relevant impact on sovereign financing premia
Keywords: Time-varying risk aversion; Ambiguity; Uncertainty; Sovereign debt; Identification via heteroscedasticity; Maxmin (search for similar items in EconPapers)
JEL-codes: C32 D80 E43 G01 H63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec, nep-fmk, nep-mac, nep-ore and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:diw:diwwpp:dp1602
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