How Do Ambiguity and Risk Aversion Affect Price Volatility under Asymmetric Information?

Abstract

This paper investigates the effects of ambiguity and risk aversion on asset price volatility when uninformed traders face ambiguity. We find that the effects of ambiguity on price volatility depend on the degree of risk aversion. If the degree of risk aversion is sufficiently low, then ambiguity has little influence on price volatility, even when the degree of ambiguity is extremely high or almost all traders have ambiguous information. In contrast, if traders are sufficiently risk‐averse, ambiguity effects on price volatility are amplified by the degree of risk aversion.