Unknown Unknowns : Uncertainty About Risk and Stock Returns

Stocks with high uncertainty about risk, as measured by the volatility of volatility (vol-of-vol), robustly underperform stocks with low uncertainty about risk by 10 percent per year. This vol-of-vol effect is distinct from (combinations of) at least twenty previously documented return predictors, survives many robustness checks, and holds in the U.S. and across European stock markets. We empirically explore the pricing mechanism behind the vol-of-vol effect. The evidence points towards preference-based explanations, and points away from various alternative explanations. Collectively, our results show that uncertainty about risk is highly relevant for stock prices