We analyze the empirical predictions of ambiguity aversion in intertemporal heterogenous agents economies. We examine equilibria for two tractable wealth-homothetic settings of ambiguity aversion in continuous time. Each setting is motivated by a different robust control optimization problem. We show that ambiguity aversion affects optimal portfolios in a way that is similar to an increase in risk aversion. A distinct property of our second setting of ambiguity aversion is that this increase is state dependent, highly pronounced at moderate portfolio exposures and reduces equity-market participation. In general equilibrium, ambiguity aversion raises the equity premium and lowers interest rates. A distinct feature of our second setting of ambiguity aversion is that the equity premium part due to ambiguity aversion dominates when volatility is low.
The paper presents a robust version of a simple two-assets Merton (1969, Review of Economics and Statistics 51, 247-57) model where the optimal choices and the implied shadow market prices of risk for a representative robust decision maker (RDM) can be easily described. With the exception of the log-utility case, precautionary behaviour is induced in the optimal consumption-investment rules through a substitution of investment in risky assets with both current consumption and riskless saving. For the log-utility case, precautionary behaviour arises only through a substitution between risky and riskless assets. On the financial side, the decomposition of the market price of risk in a standard consumption based component and a further price for model uncertainty risk (which is positively related to the robustness parameter) is independent of the underlying risk aversion parameter.
