Does ambiguity aversion reinforce risk aversion? Applications to portfolio choices and asset prices

It is often suggested that ambiguity aversion makes individuals more precautionary, thereby offering a potential explanation for the equity premium puzzle. We show that this is not true in general. We consider a model in which risk-and-ambiguity-averse agents can invest in an unambiguously safe asset and in an ambiguous risky asset. We exhibit some sufficient conditions to guarantee that, ceteris paribus, an increase in ambiguity aversion reduces the demand for the ambiguous risky asset, and raises the equity premium. For example, this is the case when the set of plausible distributions of returns can be ranked according to the monotone likelihood ratio order. We also show how ambiguity aversion distorts the price kernel.