Rational Expectations and Ambiguity: A Comment on Abel

Alexander Ludwig and Alexander Zimper

No 4066, MEA discussion paper series from Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy

Abstract: Abel (2002) proposes a resolution of the riskfree rate and the equity premium puzzles by considering pessimism and doubt. Pessimism is characterized by subjective probabilistic beliefs about asset returns that are stochastically dominated by the objective distribution of these returns. The subjective distribution is characterized by doubt if it is a mean- preserving spread of the objective distribution. This note offers a decision theoretic foundation of Abel's ad-hoc definitions of pessimism and doubt under the assumption that individuals exhibit ambiguity attitudes in the sense of Schmeidler (1989). In particular, we show that the behavior of a representative agent, who resolves her uncertainty with respect to the true distribution of asset returns in a pessimistic way, is the equivalent to pessimism in Abel's sense. Furthermore, a representative agent, who takes into account pessimistic as well as optimistic considerations, may result in the equivalent to doubt in Abel's sense.

JEL-codes: D81 G20 (search for similar items in EconPapers)
Date: 2004-12-01
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