Knightian uncertainty: evidence of uncertainty premium in the capital market

Abstract

We empirically verify two predictions of asset pricing with a role for uncertainty: return premium to increase with uncertainty, and to decrease with the resolution of uncertainty over time and experience. These properties are found among Initial Public Offerings (IPOs) of new industries where uncertainty is created by innovations of new products and services, and resolution of uncertainty from early IPOs is to decline with later IPOs. Return premium for uncertainty is shown to be separate from all known measurable risks. Evidence that uncertainty is priced also lends support to the notion that investors are in general, averse to uncertainty.