Review of Financial Studies Vol. 26 No. 7 2013
Ambiguous Volatility and Asset Pricing in Continuous Time
Abstract
We formulate a model of utility for a continuous-time framework that captures aversion to ambiguity about both volatility and drift. Corresponding extensions of some basic results in asset pricing theory are presented. First, we derive arbitrage-free pricing rules based on hedging arguments. Because ambiguous volatility implies market incompleteness, hedging arguments determine prices only up to intervals. In order to obtain sharper predictions, we apply the model of utility to a representative agent endowment economy and study equilibrium asset returns. A version of the consumption capital asset pricing model is derived, and the effects of ambiguous volatility are described.
- DOI
- 10.1093/rfs/hht018
- Volume
- 26
- Issue
- 7
- Pages
- 1740-1786
- Language
- en
- Sources
- openalex crossref