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Model Uncertainty, Limited Market Participation, and Asset Prices

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  • H. Henry Cao
  • Tan Wang
  • Harold H. Zhang

Abstract

We demonstrate that limited participation can arise endogenously in the presence of model uncertainty and heterogeneous uncertainty-averse investors. When uncertainty dispersion among investors is small, full participation prevails in equilibrium. Equity premium is related to the average uncertainty among investors and a conglomerate trades at a price equal to the sum of its single-segment components. When uncertainty dispersion is large, investors with high uncertainty choose not to participate in the stock market, resulting in limited market participation. When limited participation occurs, participation rate and equity premium can decrease in uncertainty dispersion and a conglomerate trades at a discount. Copyright 2005, Oxford University Press.

Suggested Citation

  • H. Henry Cao & Tan Wang & Harold H. Zhang, 2005. "Model Uncertainty, Limited Market Participation, and Asset Prices," The Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1219-1251.
    • Handle: RePEc:oup:rfinst:v:18:y:2005:i:4:p:1219-1251
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    File URL: http://hdl.handle.net/10.1093/rfs/hhi034
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