Belief-neutral efficiency in financial markets

Patrick Beißner and Frank Riedel
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Patrick Beißner: Center for Mathematical Economics, Bielefeld University
Frank Riedel: Center for Mathematical Economics, Bielefeld University

No 702, Center for Mathematical Economics Working Papers from Center for Mathematical Economics, Bielefeld University

Abstract: Heterogeneous beliefs among market participants can lead to questionable speculative trading that goes beyond any risk-sharing motives. We demonstrate that such unwarranted betting behavior in market equilibrium can be mitigated by introducing nonlinear pricing for ambiguous contracts, without compromising legitimate risk-hedging activities. While Arrow-Debreu equilibria generally fail to achieve belief-neutral efficiency, we establish a modified version of the first welfare theorem in which equilibria with nonlinear prices uphold belief-neutral efficiency. Moreover, we show that belief-neutral efficiency can be ensured by introducing suitable transaction costs for ambiguous financial assets.

Keywords: Belief-Neutral Pareto efficiency; Heterogeneous Beliefs; Knightian Uncertainty; Ambiguity; General Equilibrium (search for similar items in EconPapers)
Pages: 25
Date: 2025-02-27
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Persistent link: https://EconPapers.repec.org/RePEc:bie:wpaper:702

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