Learning about the persistence of recessions under ambiguity aversion

Research output: Journal PublicationArticlepeer-review

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.

Original languageEnglish
Article number102522
JournalFinance Research Letters
DOIs
Publication statusAccepted/In press - 2021

Keywords

  • Ambiguity aversion
  • Equity premium
  • Learning
  • Regime switching

ASJC Scopus subject areas

  • Finance

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