Correlation ambiguity, listing choice, and market microstructure

Abstract

This paper investigates the implication of correlation ambiguity to investor behavior, asset pricing and issuers' listing choices from a market microstructure perspective. We introduce two markets to a multi-asset model: Market A is transparent and Market B is opaque, or Market A with low and Market B with high ambiguity perceived by investors. Each firm can choose only a unique market to list its stock. Due to ambiguity aversion, a naïve investor's demand function demonstrates piecewise linear. Such trading behavior may lead to different equilibria and hence different market-clearing prices for each listing outcome. Rational entrepreneurs make optimal listing decisions depending on asset prices in alternative markets. We further demonstrate that a crafted design of specific features of the microstructure, such as listing standards and disclosure requirements, can effectively reduce the perceived ambiguity and induce more naïve investors' participation to improve market liquidity, maintain greater volume, and lower the cost of capital, so as to attract more new listings.