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APE-3: Aggregate Risk
Asset Pricing and Ambiguity: Empirical Evidence
1NYU Stern School of Business; 2Baruch College
This paper introduces ambiguity in conjunction with risk to study the relationship between risk, ambiguity and expected return. Distinguishing between ambiguity and attitudes toward ambiguity, we develop an empirical methodology for measuring the degree of ambiguity and for assessing attitudes toward ambiguity from market data. The main findings indicate that ambiguity in the equity market is priced. Introducing ambiguity alongside risk provides stronger evidence on the role of risk in explaining expected returns in the equity market. The findings also indicate that investors’ level of aversion to or love for ambiguity is contingent upon the expected probability of favorable returns.
Implied Volatility Duration and the Early Resolution Premium
Goethe University Frankfurt
We introduce Implied Volatility Duration (IVD) as a new measure for the timing of the resolution of uncertainty about a stock's cash flows. The shorter the IVD, the earlier the resolution of uncertainty. Portfolio sorts indicate that investors demand on average about seven percent return per year in exchange for a late resolution of uncertainty, and this premium cannot be explained by standard factor models. We find that the premium is higher in times of increased economic uncertainty and low market returns. In a general equilibrium model, we show that the expected excess returns on high IVD stocks can exceed those of low IVD stocks if and only if the investor's relative risk aversion exceeds the inverse of her elasticity of intertemporal substitution, i.e., if she exhibits a `preference for early resolution of uncertainty' in the spirit of Epstein and Zin (1989). Our empirical analysis thus provides a purely market-based assessment of the relation between two preference parameters, which are usually hard to estimate.
Global Variance Term Premia and Intermediary Risk Appetite
Federal Reserve Bank of New York
Sellers of variance swaps earn time-varying risk premia for their exposure to realized variance, the level of variance swap rates, and the slope of the variance swap curve. To measure risk premia, we estimate a dynamic term structure model that decomposes variance swap rates into expected variances and term premia. Empirically, we document a strong global factor structure in variance term premia across the U.S., U.K., Europe, and Japan. We further show that variance term premia are negatively correlated with the risk appetite of hedge funds, broker-dealers, and mutual funds. Our results support the hypothesis that financial intermediaries are marginal investors in the variance swap market.
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Conference: EFA 2017
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