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Learning about the persistence of recessions under ambiguity aversion

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  • Liu, Liu

Abstract

The equity premium increased greatly in the Great Recession and the COVID-19 recession. To explain the magnitude of the increase, this paper proposes a theoretical model where the representative investor is ambiguity averse towards the uncertainty over the persistence of recessions. Results show that ambiguity aversion, as opposed to risk aversion, is the key ingredient to match the sharp increase in the equity premium. Specifically, the effect of ambiguity aversion on the equity premium is asymmetric across economic expansions and recessions. By contrast, an increase in risk aversion results in weaker countercyclical variation in the equity premium.

Suggested Citation

  • Liu, Liu, 2022. "Learning about the persistence of recessions under ambiguity aversion," Finance Research Letters, Elsevier, vol. 47(PA).
    • Handle: RePEc:eee:finlet:v:47:y:2022:i:pa:s154461232100489x
    DOI: 10.1016/j.frl.2021.102522
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    References listed on IDEAS

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    More about this item

    Keywords

    Equity premium; Ambiguity aversion; Learning; Regime switching;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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