Abstract
This paper considers a stock market with ambiguity-averse informed investors under the CARA-normal setting, and studies the relationship between limited market participation and the equity premium which is decomposed into the risk premium and the ambiguity premium. In a rational expectations equilibrium, limited market participation arises if the largest deviation of investors’ ambiguity increases sufficiently or if the variance of the stock return decreases sufficiently. In each case, a change in the risk premium and a change in the ambiguity premium may have opposite signs. This paper identifies conditions under which a change with the plus sign dominates and thus the equity premium increases when fewer investors participate in the stock market. JEL classication numbers : D81, D82, G12.
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