ABSTRACT

Introduction Macroeconomists have long recognised the importance of the role of risk and uncertainty in influencing many (if not most) economic and financial decisions, particularly investment and asset portfolio decisions. As Fischer and Merton (1984) note, the common practice in macroeconomic modelling has been either to assume that investors are risk-neutral and to replace the economic variables assumed to be known with certainty in the formal model structure by their expected values, or alternatively to take account of the existence of risk and uncertainty by adding a constant risk premium to the base risk-free interest rate.