Uncertainty, Time-Varying Fear, and Asset Prices

@inproceedings{Drechsler2013UncertaintyTF,
  title={Uncertainty, Time-Varying Fear, and Asset Prices},
  author={Itamar Drechsler},
  year={2013}
}
I argue that time-varying Knightian uncertainty regarding economic fundamentals plays a central role in accounting for the equity premium, return volatility and the large, volatile variance premium embedded in equity index option prices. I build a general equilibrium framework that incorporates time-varying Knightian uncertainty about diffusive and jump shocks to the level and volatility of long-run cash-flow growth rates. A calibrated model is shown to capture the variance premium and option… CONTINUE READING

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