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Ambiguity, High Frequency Data and Asset Prices

Cenk C. Karahan
Cenk C. Karahan, PhD is an Assistant Professor of Finance at Boğaziçi University Department of Management. Dr. Karahan has received his B.S. degree in Industrial and Systems Engineering with minor degrees in Cinema-Television and Business Administration at University of Southern California. He subsequently earned his doctoral degree in Industrial and Systems Engineering department of the same university with a research focused on financial engineering. Dr. Karahan’s research and teaching interests include asset pricing, quantitative finance, behavioral finance, financial risk management and entertainment economics.
In decision-making theory, ambiguity is different from risk such that ambiguity corresponds to the situations that the probability distribution of the relevant events is unknown while risk corresponds to the situations that a (subjective or objective) unique probability distribution exists and known by the investors. In this setting, ambiguity aversion is defined as the escape behavior of ambiguous situations. In classical finance models, investors are assumed to know their utility preferences in the each state and maximize their subjective expected utility (SEU) accordingly. This assumption removes away the Knightian distinction between risk and ambiguity, making the uncertainty equals only to risk. Therefore, modern portfolio theories mainly examine the relationship between risk and return. However, in reality the investors do not know the precise probability distributions and they expose to not only risk but also ambiguity. Although the theoretical studies recently start including the ambiguity in the asset pricing models, the empirical studies are very limited in number due to the lack of sound methodology of measuring the ambiguity aversion. This study takes the practical ambiguity measure proposed by Brenner and Izhakian (2018) to a new level of practical application in testing it in Turkish stock market that offers abundant intraday data. We examine the relationship between the ambiguity and the asset returns using this novel empirical method on both market-wide level and cross-section of stock returns. Our preliminary results show that ambiguity premium is distinct from risk premium with a positive and significant magnitude. Exposure to the ambiguity differs in cross-section of stocks across characteristics like size, value, coverage, industry etc.

EMBA 102
November 11, 2019 - 13:00