Risk, ambiguity, and equity premium: International evidence

Abstract

We empirically examine the relation between risk, ambiguity, and market equity premium in 21 international stock markets. After estimating each country's degree of ambiguity from intraday data of iShares country ETFs (exchange-traded funds), we find a positive risk-return tradeoff. Investors' attitudes toward ambiguity is conditional on their expectations of probability of gains, but its relationship is nonlinear. This nonlinearity in ambiguity premium is more prominent in emerging markets. Additionally, we conduct a cross-country analysis, which shows that crosscountry variations in cultural and institutional factors affect investors' behavior. Our international evidence supports that ambiguity alongside risk are the key determinants of investors' decision-making.