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A class of tractable incomplete-market models for studying asset returns and risk exposure

François Le Grand and Xavier Ragot ()

European Economic Review, 2018, vol. 103, issue C, 39-59

Abstract: We present a class of tractable incomplete-market models, where agents face both aggregate risk and limited participation in financial markets. Tractability relies on the assumptions of small asset volumes and of a period utility function that is linear beyond a threshold, in line with Fishburn’s (1977) contribution in decision theory. We prove the existence of an equilibrium and derive theoretical results regarding asset prices and consumption choices. This small-trade model is able to reproduce a low safe return and a high equity premium, together with a realistic representation of household exposure to both idiosyncratic and aggregate risks.

Keywords: Incomplete markets; Risk sharing; Consumption inequalities (search for similar items in EconPapers)
JEL-codes: E21 E44 D91 D31 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:eecrev:v:103:y:2018:i:c:p:39-59