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Index Investing and Asset Pricing under Information Asymmetry and Ambiguity Aversion

David Hirshleifer, Chong Huang, Siew Hong Teoh

NBER Working Paper No. 24143
Issued in December 2017, Revised in June 2019
NBER Program(s):Asset Pricing Program, International Finance and Macroeconomics Program

Ambiguity aversion alone does not explain the market nonparticipation puzzle. We show that in a rational expectations equilibrium model with a fund offering the risk-adjusted market portfolio (RAMP), ambiguity averse investors hold the fund and an information-based portfolio, and thus participate in all asset markets, directly or indirectly. This result follows from a new separation theorem which states that an investor’s equilibrium portfolio can be decomposed into components, each matching the optimal portfolio based on only one information source (price versus private signal). Asset risk premia satisfy the CAPM with the fund as the pricing portfolio.

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Document Object Identifier (DOI): 10.3386/w24143

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