Markets with endogenous uncertainty: theory and policy

Graciela Chichilnisky ()

MPRA Paper from University Library of Munich, Germany

Abstract: Classic formulations of markets regard uncertainty as originating from acts of nature. I extend this to a formulation of markets which face risks induces by the economy itself, such as the environmental risks of atmospheric and climate change induced by CFC and CO2 emissions. I formulate and prove the existence of a general competitive equilibrium where the state space and the probabilities of events are endogenously determines as part of the equilibrium. Traders take optimal positions with respect to the uncertainty which their own actions induce. The equilibrium allocations are efficient in a restricted sense. I show that scientific uncertainty can be fully hedged. However uncertainty induced by the unknown level of output at an equilibrium cannot be hedged fully. I discuss applications for CAT Futures, recently introduced on the Chicago Board of Trade, and to international environmental strategies.

Keywords: endogenous uncertainty; markets general equilibrium; financial innovation; CAT futures (search for similar items in EconPapers)
JEL-codes: R13 D81 G13 (search for similar items in EconPapers)
Date: 1996
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