A General Treatment of Equilibrium under Ambiguity

In a continuous-time, pure exchange economy on a finite horizon financial agents display ambiguity aversion for a neighborhood of indistinguishable model specifications that are constrained in their relative entropy from a given reference model. We characterize equilibrium optimal consumption- portfolio choices under a general (possibly non Markovian) stochastic opportunity set by means of martingale methods and, once we restrict to the case of most commonMarkovian stochastic volatility models, we identify closed-form solutions. In an environment populated by multiple heterogeneous agents who derive utility from intertemporal consumption and terminal wealth, we investigate the impact of ambiguity aversion on asset prices from a rational expectations equilibrium perspective, using a notion of state-dependent representative agent introduced in Cuoco and He (1994). Both equilibrium interest rate and equity premium point towards a possible rationalization of the equity premium puzzle. This result is partly driven by the ability of the model to generate endogenous cycles of restricted stock market participation, achieved without imposing any a-priori trading constraint.