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Financial Uncertainty with Ambiguity and Learning

Author

Listed:
  • Hening Liu

    (Alliance Manchester Business School, University of Manchester, Manchester M15 6PB, United Kingdom)

  • Yuzhao Zhang

    (Rutgers Business School, Rutgers, The State University of New Jersey, Newark, New Jersey 07102)

Abstract

We examine a production-based asset pricing model with regime-switching productivity growth, learning, and ambiguity. Both the mean and volatility of the growth rate of productivity are assumed to follow a Markov chain with an unobservable state. The agent’s preferences are characterized by the generalized recursive smooth ambiguity utility function. Our calibrated benchmark model with modest risk aversion can match moments of the variance risk premium in the data and reconcile empirical relations between the risk-neutral variance and macroeconomic quantities and their respective volatilities. We show that the interplay between productivity volatility risk and ambiguity aversion is important for pricing variance risk in returns.

Suggested Citation

  • Hening Liu & Yuzhao Zhang, 2022. "Financial Uncertainty with Ambiguity and Learning," Management Science, INFORMS, vol. 68(3), pages 2120-2140, March.
    • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:3:p:2120-2140
    DOI: 10.1287/mnsc.2021.3958
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