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Incomplete-Market Equilibria Solved Recursively on an Event Tree

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  • Bernard Dumas
  • Andrew Lyasoff
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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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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14629.

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    Date of creation: Dec 2008
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    Publication status: published as Incomplete-Market Equilibria Solved Recursively on an Event Tree BERNARD DUMAS, ANDREW LYASOFF† Article first published online: 12 SEP 2012 DOI: 10.1111/j.1540-6261.2012.01775.x © 2012 The American Finance Association Issue The Journal of Finance The Journal of Finance Volume 67, Issue 5, pages 1897–1941, October 2012
    Handle: RePEc:nbr:nberwo:14629

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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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