Economic uncertainty: Mispricing and ambiguity premium

AbstractWe uncover two channels of effect in the financial market when investors face macroeconomic uncertainty. Conditional on a common mispricing index, we find that economic uncertainty exposure (EUE) induces disagreement, which amplifies mispricing. The highest EUE quintile produces an annualised mispricing alpha of 9.96%, more than double the unconditional mispricing effect. An ambiguity premium of 3.84% alpha is documented in the “non‐mispricing” quintile. The EUE‐induced mispricing effect is different from the existing limits of arbitrage explanations. The ambiguity premium is predictably observed during the unfolding of shocks of COVID‐19 to the market.