Ambiguity on Uncertainty and the Equity Premium

This paper considers an asset pricing model with a multiple-priors recursive utility incorporating decision makers’ concern with ambiguity on drift and jumps of driving process. Based on our empirical evidence, given a small relative risk aversion (RRA) coefficient (e.g., RRA=2), the model can well explain the equity premium puzzle, since the ambiguity aversion, as a complementary aversion of the risk aversion, can increase the equity premium and decrease the risk-free rate. This paper documents that ambiguity on uncertainty is a resolution of the equity premium puzzle.