Illiquid Asset Pricing under Knightian Uncertainty: Theory and Evidence
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| Title | Illiquid Asset Pricing under Knightian Uncertainty: Theory and Evidence
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| Author | Jinyao Gao |
| Organization | School of economics, Shandong University, Jinan |
| Email | gaojinyao@gmail.com |
| Key Words | Knightian Uncertainty; Trading Restrictions; Illiquid Asset; Asset Pricing |
| Abstract | Compared with common shares, the illiquid shares in China have a price discount about 65.2% on average. Except for the risk under-diversification caused by trading restrictions, there is another variable responsible for the price discount -- Knightian uncertainty. We approach the illiquid asset pricing problem by developing a continuous time model under Knightian uncertainty and analyze the shareholders’ behaviors in the uncertainty environment. The results show that Knightian uncertainty rises the price discounts of illiquid assets, can’t be hedged using other assets, and has first order effect on the optimal investment and consumption strategy. Using transaction data of illiquid stocks in China, we find that Knightian uncertainty can explain the price discount to a large extent, but the regression coefficient of volatility is not very significant. This empirical evidence supports the conclusion that Knightian uncertainty dominates the price discount phenomena in China. |
| Serial Number | WP415 |
| Time | 2013-02-21 |
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