Ambiguity Aversion and Incompleteness of Financial Markets

Sujoy Mukerji () and Jean-Marc Tallon ()

Papiers d'Economie Mathématique et Applications from Université Panthéon-Sorbonne (Paris 1)

Abstract: We consider a stylized bond-equity economy, which though incomplete per se, has a rich enough set of assets available for trade such that given standard assumptions about behavior under uncertainty, the equilibrium allocation would arbitrarily approximate a complete market allocation. We show, however, that when agents' beliefs are given by a set of probabilities and agents are ambiguity averse, a certain subset of the available assets will not be actually traded in equilibrium, given "sufficient" ambiguity aversion. What determines an asset's vulnerability to ambiguity aversion is whether its payoffs have an idiosyncratic component. If, (1) the range of variation of the payoff's idiosyncratic component is "large" relative to the range of the variation of the component correlated with the endowment vector and, (2) the ambiguity of the agents' common belief about the idiosyncratic component is sufficiently high, then the asset will not be traded in any general equilibrium of the finance economy. Moreover, we also find that the effect of idiosyncracy cannot simply be "washed away" by the standard techniques of diversification relying on the laws of large numbers, as it would be if the agents' beliefs were not ambiguous.

Keywords: MARKET; RISK; TRADE (search for similar items in EconPapers)
JEL-codes: D52 D81 (search for similar items in EconPapers)
Date: 1999
View citations in EconPapers

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
Working Paper: Ambiguity Aversion and Incompleteness of Financial Markets (2001)
Working Paper: Ambiguity Aversion and Incompleteness of Financial Markets (2000)
Journal Article: Ambiguity Aversion and Incompleteness of Financial Markets (2001)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:fth:pariem:1999-28

Access Statistics for this paper

More papers in Papiers d'Economie Mathématique et Applications from Université Panthéon-Sorbonne (Paris 1)
Address: France; Universite de Paris I - Pantheon- Sorbonne, 12 Place de Pantheon-75005 Paris, France
Contact information at EDIRC.
Series data maintained by Thomas Krichel ().