Research Publication

March 2022 | Working Paper

New Working Paper: “Asset Pricing under Smooth Ambiguity in Continuous Time”

Lars Peter Hansen and Jianjun Miao

Abstract

We study asset pricing implications of a revealing and tractable formulation of smooth ambiguity investor preferences in a continuous-time environment. Investors do not observe a hidden Markov state and instead make inferences about this state using past data. We show that ambiguity about this hidden state distribution alters investor decisions and equi-librium asset prices. Our continuous-time formulation allows us to apply recursive filtering and Hamilton-Jacobi-Bellman methods to solve the modified decision problem. Using such methods, we show how characterizations of portfolio allocations and local uncertainty-return trade-offs change when investors are ambiguity-averse.

Keywords— Risk, ambiguity, robustness, asset pricing, portfolio allocation, continuous time

Related: Read Research Reflection by Hansen – “Navigating Uncertainty” March 11, 2022

View on SSRN

Journal: forthcoming in the Journal of Economic Theory|Tags: Risk, Robustness and Ambiguity, Uncertainty|