I show that ambiguity (Knightian uncertainty) and learning about the equity premium can explain the fraction of financial wealth allocated to stocks over the life cycle and the stock market participation puzzle. I assume that individuals are ambiguous about the equity premium and are averse with respect to this ambiguity, which results in a lower optimal allocation to stocks over the life cycle. As agents get older, they learn about the equity premium and increase their allocation to stocks.

more »

... ort effects can be identified via learning, since each cohort has different stock market experiences and thus differ in their beliefs. Time effects are identified via decreasing fees over time. Two ways to include ambiguity aversion in the model are examined: recursive smooth preferences and maximin utility preferences. I find that if agents have maximin preferences, the empirically observed allocation to stocks can be matched. However, the stylized facts cannot be replicated when agents have smooth recursive preferences with only moderate risk aversion.