Essays on ambiguity and stock market

Abstract

The dissertation consists of two essays on ambiguity’s influence on the stock market. The first essay examines the relationship between risk, ambiguity, and expected market returns in major international stock markets. Previous studies provide a theoretical model of decision-making processes under two types of uncertainty (risk and ambiguity) and suggest how ambiguity can be empirically measured independent of risk. Under those frameworks, we estimate each country’s degree of ambiguity using intraday data of iShares country exchange-traded funds (ETFs). We find a significant and positive risk-return relation. Moreover, investors’ attitudes toward ambiguity is conditional on their expectations of the probability of favorable returns (gains). These findings hold for both world aggregate and each of continents, so our international evidence empirically supports that ambiguity alongside risk affects investors’ decision-making. The second essay investigates the time-varying relation between aggregate earnings and market returns using ambiguity. Prior studies find that the contemporaneous relation between aggregate earnings growth and market returns is negative in the U.S. but is positive in non-U.S. markets. We show that the relation does, in fact, vary over time because the predictability of aggregate earnings decreases when investors face an economic downturn and that earnings news convey more cash-flow news during periods of higher market ambiguity. Hence, the aggregate earnings-returns association becomes more positive (less negative) in times of greater market ambiguity. We find that this ambiguity effect happens both inside and outside the United States. This phenomenon is driven by large and liquid firms in the U.S. market, alongside countries with high financial transparency in international markets. Thus, our study help explain why the aggregate earnings-returns association changes over time and differs across countries.