Ambiguity aversion and the variance premium
Files
First author draft
Date
2019-06
Authors
Miao, Jianjun
Wei, Bin
Zhou, Hao
Version
First author draft
OA Version
Citation
J. Miao, B. Wei, H. Zhou. 2019. "Ambiguity Aversion and the Variance Premium" Quarterly Journal of Finance, Volume 09, Issue 02, pp.1950003-1950003. https://doi.org/10.1142/s2010139219500034
Abstract
This paper offers an ambiguity-based interpretation of the variance premium — the difference between risk-neutral and objective expectations of market return variance — as a compounding effect of both belief distortion and variance differential regarding the uncertain economic regimes. Our calibrated model can match the variance premium, the equity premium, and the risk-free rate in the data. We find that about 97% of the mean–variance premium can be attributed to ambiguity aversion. A three-way separation among ambiguity aversion, risk aversion, and intertemporal substitution, permitted by the smooth ambiguity preferences, plays a key role in our model’s quantitative performance.