Review of Finance Vol. 15 No. 2 2011
The Ambiguity Premium vs. the Risk Premium under Limited Market Participation
Abstract
This paper considers a stock market with ambiguity-averse informed investors under the CARA-normal setting, and studies the relationship between limited market participation and the equity premium which is decomposed into the risk premium and the ambiguity premium. In a rational expectations equilibrium, limited market participation arises if the largest deviation of investors’ ambiguity increases sufficiently or if the variance of the stock return decreases sufficiently. In each case, a change in the risk premium and a change in the ambiguity premium may have opposite signs. This paper identifies conditions under which a change with the plus sign dominates and thus the equity premium increases when fewer investors participate in the stock market.
- DOI
- 10.1093/rof/rfq012
- Volume
- 15
- Issue
- 2
- Pages
- 245-275
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref