Ambiguity and Nonparticipation: The Role of Regulation

Posted: 13 Apr 2009

See all articles by David Easley

David Easley

Cornell University - Department of Economics; Cornell University - Department of Information Science

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: May 2009

Abstract

We investigate the implications of ambiguity aversion for performance and regulation of markets. In our model, agents’ decision making may incorporate both risk and ambiguity, and we demonstrate that nonparticipation arises from the rational decision by some traders to avoid ambiguity. In equilibrium, these participation decisions affect the equilibrium risk premium, and distort market performance when viewed from the perspective of traditional asset pricing models. We demonstrate how regulation, particularly regulation of unlikely events, can moderate the effects of ambiguity, thereby increasing participation and generating welfare gains. Our analysis demonstrates how legal systems affect participation in financial markets through their influence on ambiguity.

Keywords: G1, G2, D8

Suggested Citation

Easley, David and O'Hara, Maureen, Ambiguity and Nonparticipation: The Role of Regulation (May 2009). The Review of Financial Studies, Vol. 22, Issue 5, pp. 1817-1843, 2009. Available at SSRN: https://ssrn.com/abstract=1376207 or http://dx.doi.org/10.1093/rfs/hhn100

David Easley (Contact Author)

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States
607-255-6283 (Phone)
607-255-2818 (Fax)

Cornell University - Department of Information Science ( email )

402 Bill & Melinda Gates Hall
Ithaca, NY 14853
United States

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3645 (Phone)
607-255-5993 (Fax)

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