Economic uncertainty: Mispricing and ambiguity premium

Charlie X. Cai; Xi Fu; Semih Kerestecioglu

doi:10.1111/eufm.12403

Economic uncertainty: Mispricing and ambiguity premium

Charlie X. Cai^*, Xi Fu, Semih Kerestecioglu

^*Corresponding author for this work

Accountancy & Finance, Finance

University of Liverpool

Research output: Contribution to journal › Article › peer-review

Abstract

We uncover two channels of effect in the financial market when investors face macroeconomic uncertainty. Conditional on a common mispricing index, we find that economic uncertainty exposure (EUE) induces disagreement, which amplifies mispricing. The highest EUE quintile produces an annualised mispricing alpha of 9.96%, more than double the unconditional mispricing effect. An ambiguity premium of 3.84% alpha is documented in the “non-mispricing” quintile. The EUE-induced mispricing effect is different from the existing limits of arbitrage explanations. The ambiguity premium is predictably observed during the unfolding of shocks of COVID-19 to the market.

Original language	English
Pages (from-to)	1702-1751
Number of pages	50
Journal	European Financial Management
Volume	29
Issue number	5
Early online date	18 Nov 2022
DOIs	https://doi.org/10.1111/eufm.12403
Publication status	Published - 1 Nov 2023

Data Availability Statement

The data used in this study are available from different resources. The data on stock market information, accounting information, analyst forecasts information and institutional ownership information are available from the Center of Research in Security Prices (CRSP), Compustat, I/B/E/S and Thomson/Refinitive via Wharton Research Data Service (WRDS), respectively. Further data used this study were derived from the following resources available in the public domain: the economic uncertainty index (https://www.sydneyludvigson.com/macro-and-financial-uncertainty-indexes), the economic policy uncertainty index (https://www.policyuncertainty.com/), mispricing scores (http://finance.wharton.upenn.edu/%7Estambaug/), equity risk factors (https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html) q factors (http://global-q.org/factors.html), the market-wide investor sentiment index (http://people.stern.nyu.edu/jwurgler/); the survey of professional forecasters (https://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters), the variance risk premium factor (https://sites.google.com/site/haozhouspersonalhomepage/), the conditional variance of forecast errors (https://sites.google.com/site/sarahmouabbi/interest-rate-uncertainty?authuser=0).

Keywords

ambiguity aversion
cross‐section of stock returns
economic uncertainty
mispricing
return predictability
risk premium

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10.1111/eufm.12403Licence: CC BY

Cai_etal_EFM_Economic_Uncertainty_Mispricing_VoR
This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided the original work is properly cited. © 2022 The Authors. European Financial Management published by John Wiley & Sons Ltd. https://creativecommons.org/licenses/by/4.0/
Final published version, 2.5 MBLicence: CC BY

Cite this

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abstract = "We uncover two channels of effect in the financial market when investors face macroeconomic uncertainty. Conditional on a common mispricing index, we find that economic uncertainty exposure (EUE) induces disagreement, which amplifies mispricing. The highest EUE quintile produces an annualised mispricing alpha of 9.96%, more than double the unconditional mispricing effect. An ambiguity premium of 3.84% alpha is documented in the “non-mispricing” quintile. The EUE-induced mispricing effect is different from the existing limits of arbitrage explanations. The ambiguity premium is predictably observed during the unfolding of shocks of COVID-19 to the market.",

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KW - cross‐section of stock returns

KW - economic uncertainty

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KW - return predictability

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JF - European Financial Management

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Economic uncertainty: Mispricing and ambiguity premium

Abstract

Data Availability Statement

Keywords

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