Asset Prices and Ambiguity

36 Pages Posted: 26 Jun 2013

See all articles by Menachem Brenner

Menachem Brenner

New York University (NYU) - Department of Finance

Yehuda (Yud) Izhakian

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Date Written: November 2011

Abstract

Modern portfolio theory, developed in the expected utility paradigm, focuses on the relationship between risk and return, assuming away ambiguity, uncertainty over the probability space. In this paper, we assume that ambiguity affects asset prices and we test the relationship between risk, ambiguity and return based on a model developed by Izhakian (2011). Our contribution is twofold; we propose an ambiguity measure that is derived theoretically and computed from intraday stock market prices. Second, we use it in conjunction with risk measures to test the basic relationship between risk, ambiguity and return. We find that our ambiguity measure has a consistently negative effect on returns and that our risk measure has mostly a positive effect. The best evidence, judging by statistical significance, is obtained when we use the change in volatility alongside the measure of ambiguity.

Suggested Citation

Brenner, Menachem and Izhakian, Yehuda (Yud), Asset Prices and Ambiguity (November 2011). NYU Working Paper No. 2451/31330, Available at SSRN: https://ssrn.com/abstract=2284649

Menachem Brenner (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0323 (Phone)
212-995-4233 (Fax)

Yehuda (Yud) Izhakian

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

HOME PAGE: http://people.stern.nyu.edu/yizhakia/

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