Probability Attitude and Non-Participation

Our paper investigates the stock non-participation puzzle through the lens of investors’ probabilistic pessimism. We depart from the conventional expected utility framework and adopt a one-period portfolio choice model under anticipated utility. We introduce a novel decision weighting function, the generalized Wang transform, to capture investors’ inverse S-shaped probability attitude. Our findings suggest that the investors’ non-linear probability attitude plays a significant role in market participation decisions. Specifically, investors are reluctant to participate in the market unless the Sharpe ratio of the market portfolio surpasses a threshold, which is determined by the degree of their probabilistic pessimism