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Does Ambiguity about Volatility Matter Empirically?

It does. Depending on the forecast horizon, a one standard deviation increase in our measure for ambiguity about consumption volatility predicts a significant increase in average excess equity returns varying between 200 and 600 basis points annualized. The ambiguity measure we propose is easily obtained from the cross-section of analysts' forecasts for aggregate output growth and represents a simple proxy for latent factors in consumption-based asset pricing models. We estimate a version of the long-run risks model, where the investor is concerned about a potential misspecification of the variance dynamics. Since the usually latent state variables are now observable, we can do this just based on fundamental cash flow data, but without the use of asset pricing information. The model produces return predictability patterns via the variance premium, which are in line with the data.