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

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Author Info
Chiaki Hara (Faculty of Economics and Politics, University of Cambridge)
Atsushi Kajii (Institute of Economic Research, Kyoto University)

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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 functions exhibit constant absolute risk aversion. These bounds are independent of the degree of market incompleteness, and so in particular 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 these bounds without the assumption of constant absolute risk aversion is also presented.

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Publisher Info
Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 577.

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Length: 23 pages
Date of creation: Nov 2003
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Handle: RePEc:kyo:wpaper:577

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Related research
Keywords: The risk-free rate puzzle; constant absolute risk aversion; incomplete markets; general equilibrium.;

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Find related papers by JEL classification:
D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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  3. Rahi Rohit, 1995. "Optimal Incomplete Markets with Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 65(1), pages 171-197, February. [Downloadable!] (restricted)
  4. David K Levine & William R Zame, 2000. "Risk Sharing and Market Incompleteness," Levine's Working Paper Archive 2080, David K. Levine. [Downloadable!]
  5. Elul, Ronel, 1997. "Financial innovation, precautionary saving and the risk-free rate," Journal of Mathematical Economics, Elsevier, vol. 27(1), pages 113-131, February. [Downloadable!] (restricted)
  6. 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. [Downloadable!]
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  8. 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. [Downloadable!] (restricted)
  9. Demange Gabrielle & Laroque Guy, 1995. "Private Information and the Design of Securities," Journal of Economic Theory, Elsevier, vol. 65(1), pages 233-257, February. [Downloadable!] (restricted)
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  10. Philippe Weil, 1992. "Equilibrium Asset Prices With Undiversifiable Labor Income Risk," NBER Working Papers 3975, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March. [Downloadable!] (restricted)
    Other versions:
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