Research / BFI Working PaperMar 17, 2022

Asset Pricing under Smooth Ambiguity in Continuous Time

Lars Peter Hansen, Jianjun Miao

We study asset pricing implications of a revealing and tractable formulation of smooth ambiguity investor preferences in a continuous-time environment. Investors do not observe a hidden Markov state and instead make inferences about this state using past data. We show that ambiguity about this hidden state distribution alters investor decisions and equilibrium asset prices. Our continuous-time formulation allows us to apply recursive filtering and Hamilton-Jacobi-Bellman methods to solve the modified decision problem. Using such methods, we show how characterizations of portfolio allocations and local uncertainty-return tradeoffs change when investors are ambiguity-averse.

Additional Materials

More Research From These Scholars

BFI Working Paper Nov 2, 2023

How Should Climate Change Uncertainty Impact Social Valuation and Policy?

Michael Barnett, William Brock, Lars Peter Hansen, Hong Zhang
Topics:  Energy & Environment
BFI Working Paper Jun 26, 2023

Monetary Policy Transmission Through Online Banks

Isil Erel, Jack Liebersohn, Constantine Yannelis, Samuel Earnest
Topics:  Monetary Policy, Financial Markets
BFI Working Paper Sep 3, 2021

Central Banking Challenges Posed by Uncertain Climate Change and Natural Disasters

Lars Peter Hansen
Topics:  Energy & Environment