Asset pricing implications of efficient risk sharing in an endowment economy

Pamela Labadie
Additional contact information
Pamela Labadie: Mount Vernon Campus, George Washington University

A chapter in Recent Developments on Money and Finance, 2006, pp 149-159 from Springer

Abstract: Summary The asset pricing behavior is studied in an overlapping generations model that is dynamically inefficient because of inefficient aggregate risk sharing. The inefficiency is linked with the stochastic distribution of income over agents within a period. The introduction of a clearing house may eliminate the dynamic inefficiency, but depending on how the clearing house operates, households may only have partial insurance against income risk. Hence, the clearing house affects the marginal rate of substitution (MRS) across generations within a period and also the intertemporal marginal rate of substitution faced by a household, which is the stochastic discount factor (SDF) applied to income streams over time. The opportunity to insure against income risk is related to different concepts of Pareto optimality. The implications for asset prices and the market price of risk are derived. In particular, the matrix of contingent claim prices supporting a Pareto optimal allocation must have a dominant root no greater than unity. This is equivalent to restricting the matrix of within-period MRS to have a dominant root no greater than unity. The sequence of powers of the pricing matrix determines the time series properties of the SDF, asset prices and asset returns.

Keywords: Asset Price; Pareto Optimality; Competitive Equilibrium; Contingent Claim; Clearing House (search for similar items in EconPapers)
Date: 2006
References: Add references at CitEc
Citations:

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

Related works:
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: https://EconPapers.repec.org/RePEc:spr:steccp:978-3-540-29500-6_7

Ordering information: This item can be ordered from
http://www.springer.com/9783540295006

DOI: 10.1007/3-540-29500-3_7

Access Statistics for this chapter

More chapters in Studies in Economic Theory from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().