Equity Trading under Heterogeneity in Ambiguity

Irasema Alonso, Mauricio Prado

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

We examine the potential importance of heterogeneity in consumers' ambiguity aversion for asset pricing, portfolio allocation, and the wealth distribution. A main focus is to explore a situation in which ambiguity aversion is \above normal", such as
when there has been a sudden inflow of market-relevant, but hard-to-interpret information: a situation like that during the onset of the recent crisis in financial markets. During this episode, market participants appeared unsure of the values of a variety of
assets, trading all but stopped. Ambiguity aversion, it appears to us, offers a tractable way of analyzing such occurrences theoretically, especially when one allows the possibility that different consumers/traders have different amounts of ambiguity aversion. By considering a model with heterogeneity on ambiguity, we explain differences in portfolio allocation, which lead to non-participation - a drastic form of trading less - in the
ambiguity-ridden market by certain agents (here we have in mind those with higher levels of ambiguity). This endogenous limited participation on the market also has implications for the relative wealth of agents in an economy. The dynamics of the wealth
distribution coming out of the model is one (of several) implications we explore. We show that the equilibrium \belief" of the ambiguity-averse consumer will evolve endogenously and nontrivially over time as a result of the equilibrium interaction. Moreover, we show that the "standard agents" will dominate in the pricing of the assets in the long run (but much less so in the short run).
Original languageEnglish
Publication date14 Feb 2013
Number of pages31
Publication statusPublished - 14 Feb 2013
EventEuropean Economic Association & Econometric Society 2013 Parallel Meetings - Gothenburg, Sweden
Duration: 26 Aug 201330 Aug 2013
http://www.eea-esem.com/eea-esem/2013/

Conference

ConferenceEuropean Economic Association & Econometric Society 2013 Parallel Meetings
CountrySweden
CityGothenburg
Period26/08/201330/08/2013
Internet address

Cite this

Alonso, I., & Prado, M. (2013). Equity Trading under Heterogeneity in Ambiguity. Paper presented at European Economic Association & Econometric Society 2013 Parallel Meetings, Gothenburg, Sweden.