We develop a model for an investor with multiple priors and aversion to ambiguity. We characterize the multiple priors by a "confidence interval" around the estimated expected returns and we model ambiguity aversion via a minimization over the priors. Our model has several attractive features:...

When the market is incomplete, a new non-redundant derivative security cannot be priced by no-arbitrage arguments alone. Moreover, there will be a multiplicity of stochastic discount factors and each of them may give a different price for the new derivative security. This paper develops an...

We evaluate the out-of-sample performance of the sample-based mean-variance model, and its extensions designed to reduce estimation error, relative to the naive 1-N portfolio. Of the 14 models we evaluate across seven empirical datasets, none is consistently better than the 1-N rule in terms of...

This paper examines the relationship between default probability and stock returns. Using the Expected Default Frequency (EDF) of Moody's KMV, we document that higher default probabilities are not associated with higher expected stock returns. Within a model of bargaining between equity holders...

We develop a new solution method for a broad class of discrete-time dynamic portfolio choice problems. The method efficiently approximates conditional expectations of the value function by using (i) a decomposition of the state variables into a component observable by the investor and a...

We demonstrate that limited participation can arise endogenously in the presence of model uncertainty and heterogeneous uncertainty-averse investors. When uncertainty dispersion among investors is small, full participation prevails in equilibrium. Equity premium is related to the average...

We study the share privatization process in China to investigate whether and how the removal of market frictions is associated with efficiency gains. Prior to the reform, domestic A-shares were divided into tradable and non-tradable shares. As a result of the reform, holders of non-tradable...

We study the effect of introducing a nonredundant derivative on the volatilities of the stock market return and the locally risk-free interest rate. Our analysis uses a standard, frictionless, full-information, dynamic, continuous-time, general-equilibrium, Lucas endowment economy in which there...

In this article we examine the effect of the imperfect mobility of goods on international risk sharing and, through that, on the investment in risky projects, welfare, and growth. Our main result is that the welfare gain from integration of financial markets is not greatly reduced by the...