Ambiguity, Information Quality and Asset Pricing

Abstract

When ambiguity averse investors process news of uncertain quality, they act as if they take a worst-case assessment of quality. As a result, they react more strongly to bad news than to good news. They also dislike assets for which information quality is poor, especially when the underlying fundamentals are volatile. These effects induce skewness in asset returns and induce ambiguity premia that depend on idiosyncratic risk in fundamentals. Moreover, shocks to information quality can have persistent negative effects on prices even if fundamentals do not change. This helps to explain the reaction of markets to events like 9/11/2001.ambiguity, information quality, asset pricing, idiosyncratic risk, negatively skewed returns