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Risk-Free Bond Prices in Incomplete Markets with Recursive Utility Functions and Multiple Beliefs

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Author Info

  • Chaiki Hara

    (Faculty of Economics and Politics, University of Cambridge)

  • Atsushi Kajii

    (Institute of Economic Research, Kyoto University)

Abstract

We consider an exchange economy under uncertainty, in which agents' utility functions exhibit constant absolute risk aversion, but they may be recursive and the expected utility calculation may be based on multiple subjective beliefs. The risk aversion coefficients, subjective beliefs, subjective time discount factors, initial endowments, and tradeable assets may differ across agents. We prove that the risk-free bond price goes down (and the interest rate goes up) monotonically as the markets become more complete. We find the range of equilibrium bond prices that depends on the primitives of the economy but not on the structures of financial markets.

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Bibliographic Info

Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 590.

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Length: 24 pages
Date of creation: May 2004
Date of revision:
Handle: RePEc:kyo:wpaper:590

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Keywords: multiple priors; no trade; dynamic consistency; interim efficiency; rectangularityi;

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  1. 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.
  2. Michael Magill & Martine Quinzii, 2002. "Theory of Incomplete Markets, Volume 1," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262632543, December.
  3. 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.
  4. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  5. Laurent Calvet & Martin Gonzalez-Eiras & Paolo Sodini, 2001. "Financial Innovation, Market Participation and Asset Prices," Harvard Institute of Economic Research Working Papers 1928, Harvard - Institute of Economic Research.
  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.
  7. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January.
  8. Epstein, Larry G. & Schneider, Martin, 2003. "Recursive multiple-priors," Journal of Economic Theory, Elsevier, vol. 113(1), pages 1-31, November.
  9. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  10. Tyge Nielsen, Lars, 1993. "The expected utility of portfolios of assets," Journal of Mathematical Economics, Elsevier, vol. 22(5), pages 439-461.
  11. Calvet, Laurent E., 2001. "Incomplete Markets and Volatility," Journal of Economic Theory, Elsevier, vol. 98(2), pages 295-338, June.
  12. Devereux, Michael B. & Saito, Makoto, 1997. "Growth and risk-sharing with incomplete international assets markets," Journal of International Economics, Elsevier, vol. 42(3-4), pages 453-481, May.
  13. Elul, Ronel, 1997. "Financial innovation, precautionary saving and the risk-free rate," Journal of Mathematical Economics, Elsevier, vol. 27(1), pages 113-131, February.
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