Endogenous Aggregate Beliefs: Equity Trading under Heterogeneity in Ambiguity Aversion

We build a simple and tractable model of consumer heterogeneity in ambiguity aversion and use it to illustrate how asymmetric beliefs in the asset markets affect the dynamics of asset pricing, portfolio allocation, and the wealth distribution. The model is an otherwise canonical exchange-economy setting with two aggregate states of nature and two assets. The key focus is on how asset prices, when subjected to ambiguity, behave very differently in the short run than in the long run. In the short run, heterogeneity plays an important role. In the long run, belief heterogeneity persists, but the wealth distribution has evolved so that only the least ambiguity-averse investors matter for prices. As part of the short-run dynamics, the model can generate endogenous aggregate movements in non-participation—a drastic form of trading less—in response to ambiguity, with strong depressing effects on asset prices.