RFS Advance Access originally published online on September 12, 2007
Review of Financial Studies 2008 21(6):2565-2597; doi:10.1093/rfs/hhm035
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Learning and Asset Prices Under Ambiguous Information
Tanaka Business School, Imperial College London
Swiss Institute of Banking and Finance, University of St. Gallen
Zurich Cantonal Bank
Address correspondence to Markus Leippold, Tanaka Business School, Imperial College London, South Kensington Campus, London SW7 2AZ, UK, or e-mail: m.leippold{at}imperial.ac.uk
JEL Classification: G1, G11, G12
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Abstract |
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In a Lucas exchange economy with standard power utility, we study asset prices under learning and ambiguous information. In contrast with models featuring only learning or ambiguity, our model is successful in matching the equity premium, the interest rate, and the volatility of stock returns under empirically reasonable parameters. Our closed-form formulas also show that a severe downward bias arises in the empirical relation between stock returns and return volatility. We quantify this bias in simulations and show that our model can explain why such a relation is difficult to detect in the data.
We are grateful to Andrew Abel, Tobias Moskowitz (the editor), and an anonymous referee for many valuable suggestions. We also thank Freddy Delbaen, David Feldman, Günter Franke, Rajna Gibson, Jens Jackwerth, Yvan Lengwiler, Marco LiCalzi, Abraham Lioui, Alessandro Sbuelz, Sandra Sizer, Pietro Veronesi, Yihong Xia, the participants of the 2004 European Summer Symposium in Financial Markets in Gerzensee, the 2005 International Finance Conference at the University of Copenhagen, the EFMA 2006 (Madrid), and of the finance seminars at the University of Basel, the University of Konstanz, the University of Frankfurt, the University of Venice, the University of Zurich, and the ETH Zurich. The authors gratefully acknowledge the financial support of the Swiss National Science Foundation (NCCR FINRISK and grants 101312-103781/1 and 100012-105745/1) and the University Research Priority Program "Finance and Financial Markets" of the University of Zurich.