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Ambiguity Aversion and Variance Premium

Jianjun Miao (), Bin Wei and Hao Zhou
Authors registered in the RePEc Author Service: Hao Zhao

No 2018-14, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: This paper offers an ambiguity-based interpretation of variance premium?the difference between risk-neutral and objective expectations of market return variance?as a compounding effect of both belief distortion and variance differential regarding the uncertain economic regimes. Our approach endogenously generates variance premium without imposing 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 postwar peak in 2009.

Keywords: ambiguity aversion; learning; variance premium; regime shifts; belief distortion (search for similar items in EconPapers)
JEL-codes: D81 E44 G12 G13 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2018-12-01
New Economics Papers: this item is included in nep-upt
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Related works:
Journal Article: Ambiguity Aversion and the Variance Premium (2019) Downloads
Working Paper: Ambiguity Aversion and Variance Premium (2012) Downloads
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DOI: 10.29338/wp2018-14

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