Optimal investment and equilibrium pricing under ambiguity

We consider portfolio selection under nonparametric alpha-maxmin ambiguity in the neighbourhood of a reference distribution. We show strict concavity of the portfolio problem under ambiguity aversion.Implied demand functions are nondifferentiable, resemble observed bid-ask spreads, and are consistent with existing parametric limiting participation results under ambiguity. Ambiguity seekers exhibit a discontinuous demand function, implying an empty set of reservation prices. If agents have identical, or sufficiently similar prior beliefs, the first best equilibrium is no trade. Simple sufficient conditions yield the existence of a Pareto-efficient second-best equilibrium which reconciles many observed phenomena in financial markets, such as liquidity dry-ups, portfolio inertia, and negative risk premia