Working Paper: NBER ID: w22416
Authors: Rhys Bidder; Ian Dewbecker
Abstract: We study an investor who is unsure of the dynamics of the economy. Not only are parameters unknown, but the investor does not even know what order model to estimate. She estimates her consumption process nonparametrically – allowing potentially infinite-order dynamics – and prices assets using a pessimistic model that minimizes lifetime utility subject to a constraint on statistical plausibility. The equilibrium is exactly solvable and we show that the pricing model always includes long-run risks. With risk aversion of 4.7, the model matches major facts about asset prices, consumption, and dividends. The paper provides a novel link between ambiguity aversion and non-parametric estimation.
Keywords: No keywords provided
JEL Codes: C14; D83; D84; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| model uncertainty (D80) | high risk premiums (G22) |
| model uncertainty (D80) | volatile asset returns (G19) |
| worst-case model (E17) | long-run risks in asset pricing (G19) |
| worst-case model (E17) | large fluctuations in equity prices (G12) |
| investor fears regarding low-frequency fluctuations (E32) | observed equity premium (G12) |
| model estimates consumption growth as white noise (C51) | worst-case model corresponds to ARMA(1,1) process (C22) |
| risk aversion coefficient (D81) | pricing implications in long-term investment horizons (G19) |