Dynamic Asset Pricing with α-MEU Model

2025-07-05

AI Summary

This paper examines dynamic asset pricing under ambiguity about the aggregate output growth rate faced by a representative agent. Ambiguity preferences are modeled using the α-maxmin expected utility (α-MEU) framework, which endogenously determines optimal portfolio allocation across risky assets, human capital, and the risk-free asset. A market equilibrium is formally defined as the consistency between individual optimal strategies and market clearing; existence and uniqueness of equilibrium are established. Analytically, we characterize how ambiguity perception intensity and ambiguity aversion jointly affect key asset prices: higher ambiguity or stronger aversion lowers the risk-free rate, raises equity prices and the equity risk premium, and reduces stock return volatility. The primary contribution is the first integration of α-MEU into a dynamic general equilibrium model with human capital, demonstrating that ambiguity can be equivalently represented—via “effective probability distortion”—within a deterministic benchmark model, and yielding novel, empirically testable asset pricing implications.

Technology Category

• Reasoning under Uncertainty: Other Foundations of Reasoning under Uncertainty
• Game Theory and Economic Paradigms: Equilibrium
• Multiagent Systems: Mechanism Design

Application Category

• Economics, Online Markets and Human Computation: Sustainability of Web economics
• Graph Algorithms and Modeling for the Web: Efficient manipulation of static and dynamic Web-related graphs
• Security and Privacy: Large-scale security measurements

Abstract

We study a dynamic asset pricing problem in which a representative agent is ambiguous about the aggregate endowment growth rate and trades a risky stock, human capital, and a risk-free asset to maximize her preference value of consumption represented by the α-maxmin expected utility model. This preference model is known to be dynamically inconsistent, so we consider intra-personal equilibrium strategies for the representative agent and define the market equilibrium as the one in which the strategy that clears the market is an intra-personal equilibrium. We prove the existence and uniqueness of the market equilibrium and show that the asset prices in the equilibrium are the same as in the case when the agent does not perceive any ambiguity but believes in a particular probabilistic model of the endowment process. We show that with reasonable parameter values, the more ambiguity the agent perceives or the more ambiguity-averse she is, the lower the risk-free rate, the higher the stock price, the higher the stock risk premium, and the lower the stock volatility.

Problem

• Dynamic asset pricing with ambiguous endowment growth
• Intra-personal equilibrium under dynamically inconsistent preferences
• Impact of ambiguity aversion on risk-free rate and stock prices

Innovation

• Uses α-MEU model for dynamic asset pricing
• Applies intra-personal equilibrium strategies
• Links ambiguity perception to asset prices