Variance Ambiguity and Inactive Trading

We introduce the ambiguity towards risk, defined as the variance of signals, as a source of investors’ uncertainty to supplement risk. When public signals arrive, all traders are informed, but they react diversely. We propose a piecewise optimal demand schedule for ambiguity-averse investors, with two inaction regions corresponding to two kinds of trading anomalies, non-participation and portfolio inertia. Specifically, households choose not to enter the stock market due to ambiguity averse, and market participants prefer to keep their positions fixed. In both situations, variance ambiguity decision-makers ignore the new-arriving signals. We find that investors tend to leave the financial market for the majority of the moderate news. However, if a surprise signal arrives, households already in the market will keep their position. Furthermore, we demonstrate that small changes to public signals may lead to plunging trading volume consequent with drastic price movements