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Ambiguity Aversion and Incompleteness of Financial Markets

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  • Sujoy Mukerji

    (University of Oxford (UK) - University of Oxford (UK))

  • Jean-Marc Tallon

    ()
    (EUREQUA - Equipe Universitaire de Recherche en Economie Quantitative - CNRS : UMR8594 - Université Paris I - Panthéon-Sorbonne)

Abstract

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

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Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number halshs-00174539.

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Date of creation: 2001
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Publication status: Published, Review of Economic Studies, 2001, 883-904
Handle: RePEc:hal:cesptp:halshs-00174539

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Keywords: incomplete markets; ambiguity aversion;

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