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25
Recursive Robust Estimation and Control Without Commitment
, 2006
"... In a Markov decision problem with hidden state variables, a posterior distribution serves as a state variable and Bayes ’ law under an approximating model gives its law of motion. A decision maker expresses fear that his model is misspecified by surrounding it with a set of alternatives that are nea ..."
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Cited by 29 (7 self)
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In a Markov decision problem with hidden state variables, a posterior distribution serves as a state variable and Bayes ’ law under an approximating model gives its law of motion. A decision maker expresses fear that his model is misspecified by surrounding it with a set of alternatives that are nearby when measured by their expected log likelihood ratios (entropies). Martingales represent alternative models. A decision maker constructs a sequence of robust decision rules by pretending that a sequence of minimizing players choose increments to a martingale and distortions to the prior over the hidden state. A risk sensitivity operator induces robustness to perturbations of the approximating model conditioned on the hidden state. Another risk sensitivity operator induces robustness to the prior distribution over the hidden state. We use these operators to extend the approach of Hansen and Sargent (1995) to problems that contain hidden states. 1
What’s vol got to do with it
 Review of Financial Studies
, 2011
"... Uncertainty plays a key role in economics, finance, and decision sciences. Financial markets, in particular derivative markets, provide fertile ground for understanding how perceptions of economic uncertainty and cashflow risk manifest themselves in asset prices. We demonstrate that the variance pre ..."
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Cited by 17 (1 self)
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Uncertainty plays a key role in economics, finance, and decision sciences. Financial markets, in particular derivative markets, provide fertile ground for understanding how perceptions of economic uncertainty and cashflow risk manifest themselves in asset prices. We demonstrate that the variance premium, defined as the difference between the squared VIX index and expected realized variance, captures attitudes toward uncertainty. We show conditions under which the variance premium displays significant time variation and return predictability. A calibrated, generalized LongRun Risks model generates a variance premium with time variation and return predictability that is consistent with the data, while simultaneously matching the levels and volatilities of the market return and risk free rate. Our evidence indicates an important role for transient nonGaussian shocks to fundamentals that affect agents ’ views of economic uncertainty and prices. We thank seminar participants at Wharton, the CREATES workshop ‘New Hope for the CCAPM?’,
Dynamic Asset Allocation with Ambiguous Return Predictability, working paper
, 2009
"... We study an investor’s optimal consumption and portfolio choice problem when he confronts with two possibly misspecified submodels of stock returns: one with IID returns and the other with predictability. We adopt a generalized recursive ambiguity model to accommodate the investor’s aversion to mode ..."
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Cited by 14 (2 self)
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We study an investor’s optimal consumption and portfolio choice problem when he confronts with two possibly misspecified submodels of stock returns: one with IID returns and the other with predictability. We adopt a generalized recursive ambiguity model to accommodate the investor’s aversion to model uncertainty. The investor deals with specification doubts by slanting his beliefs about submodels of returns pessimistically, causing his investment strategy to be more conservative than the Bayesian strategy. This effect is large for high and low values of the predictive variable. Unlike in the Bayesian framework, the hedging demand against model uncertainty may cause the investor’s stock allocations to first decrease sharply and then increase with his prior probability of the IID model, even when the expected stock return under the IID model is lower than under the predictability model. Adopting suboptimal investment strategies by ignoring model uncertainty can lead to sizable welfare costs.
An Estimation of Economic Models with Recursive Preferences. Working paper
, 2008
"... Annette VissingJorgensen for help with the stockholder consumption data. Any errors or omissions are the responsibility of the authors, and do not necessarily re‡ect the views of the National Science Foundation. An Estimation of Economic Models with Recursive Preferences This paper presents estimat ..."
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Cited by 11 (1 self)
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Annette VissingJorgensen for help with the stockholder consumption data. Any errors or omissions are the responsibility of the authors, and do not necessarily re‡ect the views of the National Science Foundation. An Estimation of Economic Models with Recursive Preferences This paper presents estimates of key preference parameters of the Epstein and Zin (1989, 1991) and Weil (1989) (EZW) recursive utility model, evaluates the model’s ability to …t asset return data relative to other asset pricing models, and investigates the implications of such estimates for the unobservable aggregate wealth return. Our empirical results indicate that the estimated relative risk aversion parameter ranges from 1760, with higher values for aggregate consumption than for stockholder consumption, while the estimated elasticity of intertemporal substitution is above one. In addition, the estimated modelimplied aggregate wealth return is found to be weakly correlated with the CRSP valueweighted stock market return, suggesting that the return to human wealth is negatively correlated with the
Ambiguity Aversion: Implications for the Uncovered Interest Rate Parity Puzzle.” Working Paper
, 2010
"... Highinterestrate currencies tend to appreciate in the future relative to lowinterestrate currencies instead of depreciating as uncoveredinterestparity (UIP) predicts. I construct a model of exchangerate determination in which ambiguityaverse agents face a dynamic filtering problem featuring ..."
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Cited by 8 (0 self)
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Highinterestrate currencies tend to appreciate in the future relative to lowinterestrate currencies instead of depreciating as uncoveredinterestparity (UIP) predicts. I construct a model of exchangerate determination in which ambiguityaverse agents face a dynamic filtering problem featuring signals of uncertain precision. Solving a maxmin problem, agents act upon a worstcase signal precision and systematically underestimate the hidden state that controls payoffs. Thus, on average, agents next periods perceive positive innovations, which generates an upward reevaluation of the strategy’s profitability and implies expost departures from UIP. The model also produces predictable expectational errors, negative skewness and timeseries momentum for currency speculation payoffs.
Ambiguity, Learning, and Asset Returns
, 2007
"... We develop a consumptionbased assetpricing model in which the representative agent is ambiguous about the hidden state in consumption growth. He learns about the hidden state under ambiguity by observing past consumption data. His preferences are represented by the smooth ambiguity model axiomatiz ..."
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Cited by 5 (0 self)
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We develop a consumptionbased assetpricing model in which the representative agent is ambiguous about the hidden state in consumption growth. He learns about the hidden state under ambiguity by observing past consumption data. His preferences are represented by the smooth ambiguity model axiomatized by Klibanoff et al. (2005, 2006). Unlike the standard Bayesian theory, this utility model implies that the posterior of the hidden state and the conditional distribution of the consumption process given a state cannot be reduced to a predictive distribution. By calibrating the ambiguity aversion parameter, the subjective discount factor, and the risk aversion parameter (with the latter two values between zero and one), our model can match the first moments of the equity premium and riskfree rate found in the data. In addition, our model can generate a variety of dynamic asset pricing phenomena, including the procyclical variation of pricedividend ratios, the countercyclical variation of equity premia and equity volatility, and the mean reversion and long horizon predictability of excess returns.
Long Run Risks and Financial Markets
, 2006
"... Recent work shows that concerns about (i) long run expected growth and (ii) uncertainty about future economic prospects, drive asset prices. These two channels of economic risks can account for the risk premia and asset price fluctuations. Hence, the long run risks model potentially provides a coher ..."
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Cited by 3 (0 self)
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Recent work shows that concerns about (i) long run expected growth and (ii) uncertainty about future economic prospects, drive asset prices. These two channels of economic risks can account for the risk premia and asset price fluctuations. Hence, the long run risks model potentially provides a coherent and systematic framework for
Confidence Risk and Asset Prices
"... Asset price movements in many cases seem delinked from aggregate economic fundamentals. Forexample, RaviBansal andIvanShaliastovich (2008a) show that frequent large moves in asset prices, i.e. jumps, on average are not correlated with movements in macrovariables (see Table 1 below). Motivated by t ..."
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Cited by 3 (0 self)
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Asset price movements in many cases seem delinked from aggregate economic fundamentals. Forexample, RaviBansal andIvanShaliastovich (2008a) show that frequent large moves in asset prices, i.e. jumps, on average are not correlated with movements in macrovariables (see Table 1 below). Motivated by this, we present a general equilibrium model in which variation in investor confidence about expected growth determines risk premia and hence asset prices. This confidence risk channel can account for (i) the lack of connection between large assetprice moves and macrovariables such as consumption, (ii)large declinesinassetprices, thatis, the left tail of the return distribution, and (iii) observed predictability of equity returns and consumption growth by the price to dividend ratio. In essence, we present a model in which behaviorally motivated shifts in expectations play an important role for the asset prices. Our economy setup follows a standard longrun risks specification of Ravi Bansal and Amir Yaron (2004), and features Gaussian consumption growth process with timevarying expected growth and volatility; there are no large moves orjumpsintheunderlyingconsumptionanddividenddynamics. Expectedgrowth isnotdirectly observable, and investors learn about it using the crosssection of signals. The timevarying crosssectional varianceof thesignals determines the quality of the information, and therefore the confidence that investors place in their growth forecast. In the longrun risks framework, the fluctuations in confidence risk determines risk premia and asset prices. We model investors as being recencybiased in their expectation formation, that is, they overweigh recent observations as in Werner De Bondt and Richard Thaler (1990). This is important, as in the standard KalmanFilter based expectation formation, periods of low information quality get downweighted, which diminishes the role of the confidence risk channel.
LongRun Productivity Risk: A New Hope for . . .
, 2008
"... This study examines the intertemporal distribution of productivity risk. Focusing on postwar US data, I show that the conditional mean of productivity growth is timevarying and extremely persistent. This generates uncertainty about the longrun perspectives of economic growth and affects asset pri ..."
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Cited by 2 (0 self)
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This study examines the intertemporal distribution of productivity risk. Focusing on postwar US data, I show that the conditional mean of productivity growth is timevarying and extremely persistent. This generates uncertainty about the longrun perspectives of economic growth and affects asset prices. The data suggest that stock market prices are very sensitive to longrun news about productivity growth. After establishing this empirical link, I develop a productionbased asset pricing model featuring longrun uncertainty about the productivity growth rate, convex adjustment costs, and recursive preferences à la EpsteinZin. This model reproduces key features of both asset prices and macroeconomic quantities, including consumption, investment, and output. I also provide a detailed examination of the role of the intertemporal elasticity of substitution, relative risk aversion, and adjustment costs in this type of economy.