Limited participation under ambiguity of correlation

Helen Hui Huang, Shunming Zhang () and Wei Zhu

Journal of Financial Markets, 2017, vol. 32, issue C, 97-143

Abstract: In this paper, we investigate the implications of correlation ambiguity for investor behaviors and asset prices. In our model, individuals' decision making incorporates both risk and ambiguity, and we demonstrate that limited participation arises from the rational decision by naïve investors to avoid correlation ambiguity. In equilibrium, the asset with lower quality generates positive excess returns. Comparative static analysis of the equilibrium result suggests that changes in the fraction of naïve investors and ambiguity level can alter equilibrium types and flight to quality phenomenon is observed. However, their impacts on asset prices are non-monotonic.

Keywords: Ambiguity aversion; Correlation ambiguity; General equilibrium; Limited participation; Flight to quality (search for similar items in EconPapers)
JEL-codes: D80 D81 G02 G11 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finmar:v:32:y:2017:i:c:p:97-143

DOI: 10.1016/j.finmar.2016.10.002

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