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Microstructure and Ambiguity


  • Easley is from the Department of Economics, Cornell University. O'Hara is from Johnson Graduate School of Management, Cornell University. We would like to thank Judson Caskie, Scott Condie, Thiery Foucault, Simon Gervais, Carole Gresse, Tim Riddiough, Gideon Saar, two referees, and Cam Harvey (the Editor), as well as seminar participants at Collegio Carlo Alberto, Cornell, HKUST, ISCTE, Singapore Management University, the University of Miami, the University of Porto, the University of Wisconsin, the Euronext—Universite Paris Dauphine conference (March 2006), the NBER Market Microstructure meetings (May 2007), and the Western Finance Association Meetings (2007) for helpful comments and suggestions.


A goal for stock exchanges is to increase participation by firms and investors. We show how specific features of the microstructure can reduce perceived ambiguity, and induce participation by both investors and issuers. We develop a model with sophisticated traders, who we view as expected utility maximizers with rational expectations, and unsophisticated traders, who we view as rational traders facing ambiguity about the payoffs to participating in the market. We show how designing markets to reduce ambiguity can benefit investors through greater liquidity, exchanges through greater volume, and issuing firms through a lower cost of capital.