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Ambiguity, information acquisition and price swings in asset markets
01 Jan 2009-LSE Research Online Documents on Economics (London School of Economics and Political Science, LSE Library)-
TL;DR: In this article, the authors study asset markets in which ambiguity averse investors face Knightian uncertainty about expected payos, and suggest the importance of uncertainty, as a new channel for episodes of extreme price volatility, media frenzies and media glooms.
Abstract: This paper studies asset markets in which ambiguity averse investors face Knightian uncertainty about expected payos. The same investors, however, might wish to resolve their uncertainty, although not risk, by just purchasing information. In these markets, uninformed and, hence, ambiguity averse, agents may coexist with informed agents, as a result of a rational information acquisition process. Moreover, there are complementaries in information acquisition, multiplicity of equilibria, history-dependent prices, and large price swings occurring after small changes in the uncertainty surrounding the asset expected payos. Our model suggests the importance of uncertainty, as a new channel for episodes of extreme price volatility, media frenzies and media glooms.
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TL;DR: This article conducted a survey of the existing literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices, and concluded that the ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions.
Abstract: A growing body of empirical evidence suggests that investors’ behavior is not well described by the traditional paradigm of (subjective) expected utility maximization under rational expectations. A literature has arisen that models agents whose choices are consistent with models that are less restrictive than the standard subjective expected utility framework. In this paper we conduct a survey of the existing literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. We conclude that the ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions, such as the empirical failure of the two-fund separation theorem in portfolio decisions, the modest exposure to risky securities observed for a majority of investors, the home equity preference in international portfolio diversification, the excess volatility of asset returns, the equity premium and the risk-free rate puzzles, and the occurrence of trading break-downs.
118 citations
TL;DR: The authors reviewed models of ambiguity aversion and showed that such models have implications for portfolio choice and asset pricing that are very different from those of SEU and that help to explain otherwise puzzling features of the data.
53 citations
TL;DR: In this article, a no-arbitrage framework is introduced to assess how macroeconomic factors help explain the risk-premium agents require to bear the risk of fluctuations in stock market volatility.
Abstract: This paper introduces a no-arbitrage framework to assess how macroeconomic factors help explain the risk-premium agents require to bear the risk of fluctuations in stock market volatility. We develop a model in which return volatility is stochastic and derive no-arbitrage conditions linking volatility to macroeconomic factors. We estimate the model using data related to variance swaps, which are contracts with payoffs indexed to nonparametric measures of realized volatility. We find that volatility risk-premia are strongly countercyclical and that in turn, they are of substantial help in predicting future economic activity.
44 citations
01 Jan 2018
TL;DR: In this article, a quantitative study was conducted to examine the net gains from alternative trading techniques that can be utilized by currency managers working for international banks and hedge funds when trading the EUR/USD currency on an intraday basis.
Abstract: Global financial institutions provide a mechanism for multinational corporations to hedge against exchange rate risk via currency futures contracts and spot exchange rates. Currency managers working at these global financial institutions overseeing EUR/USD spot currency traders lack adequate data to determine if alternative trading tools could increase net gains for their respective firms. The purpose of this quantitative study was to examine the net gains from alternative trading techniques that can be utilized by currency managers working for international banks and hedge funds when trading the EUR/USD currency on an intraday basis. A buy and hold strategy, sell and hold strategy, and a Bollinger Band strategy were applied to tick level sample data gathered from 2009 to 2016 to determine net gains from each strategy. The results of an ANOVA test indicate there is a statistically significant difference, however the Bollinger Band strategy produced an overall net loss from trading. The findings suggest that using an alternative trading strategy, Bollinger Bands, on an intraday basis does not increase net gains from trading activity.
9 citations
TL;DR: In this paper, the authors consider a dynamic general equilibrium model of asset trading with private information and collateral constraints and show that when uncertainty is high, some investors exit the market, and when exiting investors' information is not fully revealed by prices, conditional return volatility and risk premia both increase.
2 citations