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Working paper

Testing for Ambiguity Aversion in the Russian Stock Market

Esaulov D., Davidovich M.
This paper represents the first comprehensive empirical study on ambiguity and risk in the Russian stock market. Modern portfolio theory assumes that there is a linear relationship between risk and return and known probabilities of outcomes. This risk-return relationship plays an important role in the financial literature, however, there is no clear empirical evidence on the sign and significance of risk- return tradeoff. Some financial literature argues that risk is not enough to measure the expected returns on the market portfolio. One possible reason for this is an assumption that rational decision makers know the probabilities of outcome that affects asset prices. In this paper the assumption of known probabilities is relaxed. We test the relationship between risk, ambiguity and return of intraday observations on MICEX index for the period 2009-2016 using GARCH-M approach, which allows for heteroscedasticity of returns. Ambiguity is derived from the model developed by Brenner and Izhakian (2011), which is modified to capture the non-normality of the distribution of returns in the Russian equity market. Expected returns appear to have a positive and statistically significant relationship with conditional volatility modeled by GARCH and EGARCH processes. We found out that coefficient of ambiguity is not statistically significant, which can be the evidence of ambiguity-neutral behavior of Russian investors. To the best of our knowledge, this paper is the first empirical work that derives ambiguity, accounting for its specificity, and tests the risk-ambiguity- return relationship in the Russian stock market.