Project Significance:
We model the dynamics of asset prices in general equilibrium with intermediary sector in segmented markets where households (infra-marginal investor) and specialists (marginal investor) have heterogeneous ambiguity. The model produces mechanisms of how heterogeneous ambiguity transmits into asset market and generates amplification effect both in and out of financial crisis. The heterogeneity can never be aggregated away in equilibrium since both ambiguities will induce low total risk exposure and asset price, as well as high risk premium and Sharpe ratio, with the latter dominated by marginal investor's ambiguity under constraint. During financial crisis, two ambiguities are endogenous in effective financial constraint as a scaled ratio thus accelerate the tightness of equity capital constraint in opposite direction. Higher household ambiguity lowers risky asset portfolio share by i) increasing wealth contribution into intermediation due to demand for expertise and ii) matching higher total equity capital with lower risky asset price in general equilibrium. On the contrary, a rise in marginal investor's ambiguity will increase the risky asset portfolio holding because of i) losing household equity capital by losing expertise and ii) lower asset price and higher return trigger a higher portfolio demand for risky asset. Under observational equivalence with homogeneous effective risk aversion and lower specialist ambiguity, the heterogeneity aggregates out through effective financial constraint. During non-crisis, higher specialist ambiguity lowers the risk exposure contract share and risky asset volatility. Moreover, asset price dynamics with heterogeneous ambiguity are endogenously determined in closed forms as functions of specialist's wealth. We solve the wealth process in general equilibrium which is highly non-linear but non-degenerate in steady state after considering ambiguity. The wealth distribution is stationary and fat-tailed by simulation. We also show non-unit elasticity of substitution in recursive utility only changes goods market but not effective financial constraint thus won't change the major asset price dynamics.
