65 Pages Posted: 16 Jun 2012 Last revised: 11 Aug 2020
Date Written: March 2, 2020
We show that aversion to risk and ambiguity leads to information inertia when investors process public news about assets. Optimal portfolios do not always depend on news that is worse than expected; hence, the equilibrium stock price does not reflect this bad news. This informational inefficiency is more severe when there is more risk and ambiguity but disappears when investors are risk neutral or the news is about idiosyncratic risk. Information inertia leads to news momentum (e.g. after earnings announcements) and is consistent with low trading activity of households. An ambiguity premium helps explain the macro and earnings announcement premium.
Keywords: Ambiguity Aversion, Knightian Uncertainty, Inattention to News, Informational Efficiency, Information Inertia, News Momentum, Post-Earnings Announcement Drift (PEAD), Post-Forecast Revision Drift (PFRD)
JEL Classification: D80, D81, G10, G11, G12, G14
Suggested Citation: Suggested Citation