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On the Range of the Risk-Free Interest Rate in Incomplete Markets

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  • Kajii, A.
  • Hara, C.

Abstract

In a model of a two-period exchange economy under uncertainty, we find both upper and lower bounds for the risk free interest rate when the agents’ utility function exhibit constant absolute risk aversion. 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 bounds without the assumption of constant absolute risk aversion is also presented.

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File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/wp0030.pdf
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Bibliographic Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0030.

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Date of creation: Dec 2000
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Handle: RePEc:cam:camdae:0030

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  1. Ohashi Kazuhiko, 1995. "Endogenous Determination of the Degree of Market-Incompleteness in Futures Innovation," Journal of Economic Theory, Elsevier, vol. 65(1), pages 198-217, February.
  2. Weil, Philippe, 1992. "Equilibrium asset prices with undiversifiable labor income risk," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 769-790.
  3. Elul, Ronel, 1997. "Financial innovation, precautionary saving and the risk-free rate," Journal of Mathematical Economics, Elsevier, vol. 27(1), pages 113-131, February.
  4. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
  5. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
  6. Demange, G. & Laroque, G., 1992. "Private Information and the Design of Securities," DELTA Working Papers 92-22, DELTA (Ecole normale supérieure).
  7. Tyge Nielsen, Lars, 1993. "The expected utility of portfolios of assets," Journal of Mathematical Economics, Elsevier, vol. 22(5), pages 439-461.
  8. David K Levine & William R Zame, 2000. "Risk Sharing and Market Incompleteness," Levine's Working Paper Archive 2080, David K. Levine.
  9. Laurent Calvet & Jean-Michel Grandmont & Isabelle Lemaire, 2001. "Aggregation of Heterogenous Beliefs and Asset Pricing in Complete Financial Markets," Working Papers 2001-01, Centre de Recherche en Economie et Statistique.
  10. Rahi Rohit, 1995. "Optimal Incomplete Markets with Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 65(1), pages 171-197, February.
  11. David K. Levine & William R. Zame, 2002. "Does Market Incompleteness Matter?," Econometrica, Econometric Society, vol. 70(5), pages 1805-1839, September.
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Cited by:
  1. David K. Levine & William Zame, 2001. "Does Market Incompleteness Matter," Levine's Working Paper Archive 78, David K. Levine.

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