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Ambiguity Aversion and Incompleteness of Financial Markets

Sujoy Mukerji () and Jean-Marc Tallon ()

No 46, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: It is widely thought that incomes risks can be shared by trading in financial assets. But financial assets typically carry some risk idiosyncratic to them, hence, disposing incomes risk using financial assets will involve buying into the inherent idiosyncratic risk. However, standard theory argues that diversification would reduce the inconvenience of idiosyncratic risk to arbitrarily low levels. This argument is less robust than what standard theory leads us to believe: ambiguity aversion can exacerbate the tension between the two kinds of risk to the point that classes of agents may not want to trade some financial assets. Thus, theoretically , the effect of ambiguity aversion on financial markets is to make the risk sharing opportunities offered by financial markets less complete than it would be otherwise.

Keywords: ambiguity aversion; incomplete markets; sub-optimal risk sharing (search for similar items in EconPapers)
JEL-codes: D81 D52 (search for similar items in EconPapers)
Date: 2000-12-01
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Journal Article: Ambiguity Aversion and Incompleteness of Financial Markets (2001) Downloads
Working Paper: Ambiguity Aversion and Incompleteness of Financial Markets (2001) Downloads
Working Paper: Ambiguity Aversion and Incompleteness of Financial Markets (1999)
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