Presenter: Marie-Louise Vierø, AU

Title: Unawareness Premia

Abstract: This paper considers the effect on asset prices of investors contemplating the possible occurrence of unexpected and unprecedented events that they have no basis to evaluate.
We build a Capital Asset Pricing Model (CAPM) where, in addition to regular risk, investors are aware that they are potentially unaware of some events. We show that when investors feel that there exist states about which they are unaware, asset prices contain an unawareness premium. A driving force is that the "risk free" asset is no longer considered to be truly risk free. We develop a methodology that enables us to estimate the systematic portion of the unawareness premium, and we estimate it using daily data from 1980 to 2020. This unawareness premium implies a theoretical motivation behind the correlation between estimated asset alphas and betas in the cross section. We find evidence in support of the hypothesis that unawareness, in addition to risk, is a determinant of expected equity returns. This additional factor adds insights into asset market behavior around market run ups like those during the dotcom boom and the pre-financial crisis market outperformance.

Presenter: Stefan Hirth, AU

Title: Credit Rating under Ambiguity

Abstract: We consider the impact of ambiguity on credit rating with feedback effects. A firm signals its quality by surviving phases of apparent distress. A rating agency, whose analysts hold multiple priors about the firm’s true asset value, for example, due to the difficulties in the valuation of intangible assets, aims for unbiased ratings. Contrasting classical min-max results, the rating agency selects a dynamically adjusted weighted average of multiple beliefs that overweight uninformative beliefs. The ambiguity impact on ratings hinges on whether the disagreement between the analysts has a common direction: When analysts jointly perceive the firm’s value of intangibles as overstated, feedback effects make the firm delay default to benefit from the rating agency’s learning.

Organizers: Stefan Hirth and Anders Merrild Posselt