Segmentation and beliefs: A theory of self-fulfilling idiosyncratic risk

Paymon Khorrami and Alexander K. Zentefis

Journal of Economic Theory, 2025, vol. 223, issue C

Abstract: We study a multi-location general equilibrium model with financial market segmentation that permits self-fulfilling fluctuations. In a precise sense, such fluctuations are most often redistributive, but their volatility varies systematically with an aggregate latent factor. We thus provide a coordination-based microfoundation for time-varying idiosyncratic risk. A key assumption of our analysis is that cash flow growth rates (e.g., firm profit growth, asset dividend growth, or country output growth) rise with valuations. We consider two applications: (i) firm dynamics and their risk factor structure; and (ii) exchange rate disconnect in international macroeconomics.

Keywords: Idiosyncratic risk; Segmented markets; Volatility; Asset pricing; Multiple equilibria (search for similar items in EconPapers)
JEL-codes: D84 G11 G12 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:223:y:2025:i:c:s0022053124001601

DOI: 10.1016/j.jet.2024.105954

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