Bounds on the Risk-Free Interest Rate in Incomplete Markets With and Without Utility Functions Exhibiting Constant Absolute Risk Aversion

Chiaki Hara ()

No 1448, Econometric Society World Congress 2000 Contributed Papers from Econometric Society

Abstract: In a model of a two-period exchange economy under uncertainty, we find an upper bound for the equilibrium risk-free interest rate when the expected aggregate endowment in the second period is no greater than the first-period aggregate endowment. We also find a lower bound when the agents' utility functions exhibit constant absolute risk aversion and the expected aggregate endowment in the second period is no smaller than the first-period counterpart. These bounds are independent of the degree of market incompleteness, and so these results show to what extent market incompleteness can explain the risk-free rate puzzle in this class of general equilibrium models with heterogeneous agents. A general method of finding lower bounds is also presented.

Date: 2000-08-01
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