Ambiguity premium and transaction costs

Jang, Bong-Gyu; Kim, Taeyoon; Lee, Seungkyu; Park, Seyoung

Abstract

We generalize the optimal investment model of an ambiguity averse investor with transaction costs. Along the lines of Maenhout (2004), we first show that ambiguity (or model uncertainty) leads to an increase in effective risk aversion by ambiguity aversion even with transaction costs. We compute the utility cost associated with suboptimal investment decisions, which is the so-called ambiguity premium. We then find that ignoring ambiguity aversion with and without transaction costs generates large ambiguity premia when ambiguity aversion is moderate, and the cost of ignoring it becomes larger with higher ambiguity aversion. This would, thus, still support the importance of ambiguity aversion channel for portfolio choice, even concerning the friction markets.

Citation

Jang, B.-G., Kim, T., Lee, S., & Park, S. (2021). Ambiguity premium and transaction costs. Economics Letters, 207, Article 110007. https://doi.org/10.1016/j.econlet.2021.110007

• Journal Article Type: Article
• Acceptance Date: Jul 16, 2021
• Online Publication Date: Aug 9, 2021
• Publication Date: 2021-10
• Deposit Date: Apr 27, 2023
• Publicly Available Date: Aug 10, 2023
• Journal: Economics Letters
• Print ISSN: 0165-1765
• Electronic ISSN: 1873-7374
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 207
• Article Number: 110007
• DOI: https://doi.org/10.1016/j.econlet.2021.110007
• Keywords: Economics and Econometrics; Finance
• Public URL: https://nottingham-repository.worktribe.com/output/20003137
• Publisher URL: https://www.sciencedirect.com/science/article/abs/pii/S0165176521002846?via%3Dihub