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Model Uncertainty, Ambiguity Aversion, and Market Participation

43 Pages Posted: 17 Jan 2017 Last revised: 30 Sep 2017

David A. Hirshleifer

University of California, Irvine - Paul Merage School of Business; NBER

Chong Huang

University of California, Irvine - Paul Merage School of Business

Siew Hong Teoh

University of California, Irvine - Accounting Area

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Date Written: September 29, 2017

Abstract

Ambiguity aversion is a leading explanation for the market nonparticipation puzzle. However, we show that in a rational expectations equilibrium model with a fund offering the risk-adjusted market portfolio (RAMP), all investors, including those who are ambiguous about some or all assets, participate in all asset markets directly or via the fund. This result follows from a new separation theorem. In equilibrium, the asset risk premia satisfy the CAPM with the fund as the pricing portfolio. We conclude that considerations other than ambiguity aversion alone, such as a failure of funds to offer RAMP or other forms of investor bias, are needed to explain the nonparticipation puzzle.

Keywords: index fund, limited participation, ambiguity aversion, risk premium

JEL Classification: G11, G12, D84

Suggested Citation

Hirshleifer, David A. and Huang, Chong and Teoh, Siew Hong, Model Uncertainty, Ambiguity Aversion, and Market Participation (September 29, 2017). Available at SSRN: https://ssrn.com/abstract=2898992 or http://dx.doi.org/10.2139/ssrn.2898992

David Hirshleifer

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States

HOME PAGE: http://sites.uci.edu/dhirshle/

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Chong Huang (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA 92697-3125
United States

Siew Hong Teoh

University of California, Irvine - Accounting Area ( email )

Irvine, CA 92697-3125
United States

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