Model Uncertainty, Ambiguity Aversion,and Market Participation

David Hirshleifer, Chong Huang, and Siew Hong Teoh

September 2017


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.

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