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Incomplete-Market Equilibria Solved Recursively on an Event Tree

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Author Info

  • Bernard DUMAS

    (University of Lausanne, Swiss Finance Institute, NBER and CEPR)

  • Andrew LYASOFF

    (Boston University)

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    Abstract

    We develop a method that allows one to compute incomplete-market equilibria routinely for Markovian equilibria (when they exist). The main difficulty to be overcome arises from the set of state variables. There are, of course, exogenous state variables driving the economy but, in an incomplete market, there are also endogenous state variables, which introduce path dependence. We write on an event tree the system of all first-order conditions of all times and states and solve recursively for state prices, which are dual variables. We illustrate this “dual” method and show its many practical advantages by means of several examples.

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    File URL: http://ssrn.com/abstract=1326298
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    Bibliographic Info

    Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-49.

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    Length: 43 pages
    Date of creation:
    Date of revision:
    Handle: RePEc:chf:rpseri:rp0849

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    Web page: http://www.SwissFinanceInstitute.ch
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    Related research

    Keywords: incomplete market; financial-market equilibrium; computation; recursive methods;

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    Cited by:
    1. Georgy Chabakauri, 2010. "Asset pricing with heterogeneous investors and portfolio constraints," LSE Research Online Documents on Economics 43142, London School of Economics and Political Science, LSE Library.

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