Ambiguity and the historical equity premium.

This paper assesses the quantitative impact of ambiguity on the historically observed financial asset returns and prices. The single agent, in a dynamic exchange economy, treats uncertainty about the conditional mean of the probability distribution on consumption and dividends in the next period as ambiguous, an ambiguity that is endogenously dynamic, e.g., increasing during recessions. We calibrate ambiguity aversion to match only the first moment of the risk-free rate in data and, importantly, the (conditional) ambiguity to match the uncertainty conditional on the actual history of macroeconomic growth outcomes. The model matches observed asset return dynamics very substantially.