This paper considers a stock market with ambiguity-averse informed investors
under the CARA-normal setting, and studies the relationship between limited mar-
ket participation and the equity premium which is decomposed into the risk premium
and the ambiguity premium. In a rational expectations equilibrium, limited market
participation arises if the largest deviation of investors’ ambiguity increases suffi-
ciently or if the variance of the stock return decreases sufficiently. In each case, a
change in the risk premium and a change in the ambiguity premium may have oppo-
site signs. This paper identifies conditions under which a change with the plus sign
dominates and thus the equity premium increases when fewer investors participate
in the stock market.