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Ambiguity aversion and the absence of indexed debt

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  • Sujoy Mukerji

    ()

  • Jean-Marc Tallon

    ()

Abstract

Following the seminal works of Schmeidler (1989), Gilboa and Schmeidler (1989), roughly put, an agent’s subjective beliefs are said to be ambiguous if the beliefs may not be represented by a unique probability distribution, in the standard Bayesian fashion, but instead by a set of probabilities. An ambiguity averse decision maker evaluates an act by the minimum expected value that may be associated with it. In spite of wide and long-standing support among economists for indexation of loan contracts there has been relatively little use of indexation, except in situations of extremely high inflation. The object of this paper is to provide a (theoretical) explanation for this puzzling phenomenon based on the hypothesis that economic agents are ambiguity averse. The paper considers a general equilibrium model based on Magill and Quinzii (1997) with ambiguity averse agents, where both nominal and indexed bond contracts are available for trade and all relevant prices are determined endogenously. We obtain conditions which prompt an endogenous cessation of trade in indexed bonds: i.e., conditions under which there is no trade in indexed bonds in any equilibrium; only nominal bonds are traded. Copyright Springer-Verlag Berlin/Heidelberg 2004

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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 24 (2004)
Issue (Month): 3 (October)
Pages: 665-685

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Handle: RePEc:spr:joecth:v:24:y:2004:i:3:p:665-685

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Keywords: Debt indexation; Ambiguity; Ambiguity aversion.;

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Cited by:
  1. Mukerji, Sujoy & Tallon, Jean-Marc, 2003. "Ellsberg's two-color experiment, portfolio inertia and ambiguity," Journal of Mathematical Economics, Elsevier, vol. 39(3-4), pages 299-316, June.
  2. Martin Cincibuch & Matrina Horníková, 2008. "Measuring the Financial Markets’ Perception of EMU Enlargement: The Role of Ambiguity Aversion," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 58(05-06), pages 210-230, August.
  3. Mukerji, Sujoy & Tallon, Jean-Marc, 2004. "Ambiguity aversion and the absence of wage indexation," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 653-670, April.
  4. Sujoy Mukerji & Jean-Marc Tallon, 2003. "An overview of economic applications of David Schmeidler`s models of decision making under uncertainty," Economics Series Working Papers 165, University of Oxford, Department of Economics.
  5. Larry G. Epstein & Martin Schneider, 2010. "Ambiguity and Asset Markets," NBER Working Papers 16181, National Bureau of Economic Research, Inc.
  6. Martin Schneider, 2010. "The Research Agenda: Martin Schneider on Multiple Priors Preferences and Financial Markets," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 11(2), April.
  7. repec:hal:journl:halshs-00174562 is not listed on IDEAS
  8. Shin-ichi Fukuda, 2012. "Infrequent Changes of the Policy Target: Robust Optimal Monetary Policy under Ambiguity," CARF F-Series CARF-F-295, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  9. Verónica Balzarotti, 2006. "Real Interest Rate Risk in the Argentine Banking System. A Measuring Model," BCRA Working Paper Series 200606, Central Bank of Argentina, Economic Research Department.
  10. Jean-Marc Tallon & Sujoy Mukerji, 2004. "Ambiguity aversion and the absence of wage indexation," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00174562, HAL.

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