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Ambiguity Aversion and Incompleteness of Financial Markets

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Author Info
Sujoy Mukerji
Jean-Marc Tallon

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Abstract

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

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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 046.

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Date of creation: 2000
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Handle: RePEc:oxf:wpaper:046

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Keywords: ambiguity aversion incomplete markets sub-optimal risk sharing

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Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Sujoy Mukerji & Jean-Marc Tallon, 2003. "An overview of economic applications of David Schmeidler`s models of decision making under uncertainty," Economics Series Working Papers 172, University of Oxford, Department of Economics. [Downloadable!]
    Other versions:
  2. Stoneman, Paul & Canepa, Alessandra & Kaivanto, Kim, 2004. "The Public Provision of Sales Contingent Contracts as a Policy Response to Financial Constraints to Innovation in European SMEs," EIFC - Technology and Finance Working Papers 38, United Nations University, Institute for New Technologies. [Downloadable!]
    Other versions:
  3. Fabio Maccheroni & Massimo Marinacci & Aldo Rustichini, 2006. "Dynamic Variational Preferences," Carlo Alberto Notebooks 1, Collegio Carlo Alberto. [Downloadable!]
    Other versions:
  4. Larry Epstein & Martin Schneider, 2005. "Ambiguity, Information Quality and Asset Pricing," RCER Working Papers 519, University of Rochester - Center for Economic Research (RCER). [Downloadable!]
    Other versions:
  5. Thibault Gajdos & Takashi Hayashi & Jean-Marc Tallon & Jean-Christophe Vergnaud, 2008. "Attitude toward imprecise information," Post-Print halshs-00177378_v1, HAL. [Downloadable!]
    Other versions:
  6. Gomes, F. A. R., 2007. "The Effect of Future Income Uncertainty in Savings Decision," Ibmec Working Papers wpe_72, Ibmec Working Paper, Ibmec São Paulo. [Downloadable!]
  7. Jürgen Eichberger & David Kelsey, 2007. "Ambiguity," Working Papers 0448, University of Heidelberg, Department of Economics, revised Jul 2007. [Downloadable!]
  8. Thibault Gajdos & Jean-Marc Tallon & Jean-Christophe Vergnaud, 2002. "Coping with imprecise information : a decision theoretic approach," Cahiers de la Maison des Sciences Economiques v04056, Université Panthéon-Sorbonne (Paris 1), revised May 2004. [Downloadable!]
  9. Luca Rigotti & Chris Shannon, 2001. "Uncertainty and Risk in Financial Markets," Department of Economics, Working Paper Series 1000, Department of Economics, Institute for Business and Economic Research, UC Berkeley. [Downloadable!]
    Other versions:
  10. Simon Grant & Jeff Kline & John Quiggin, 2006. "Lost in Translation: Honest Misunderstandings and Ex Post Disputes," Risk & Uncertainty Working Papers WP3R06, Risk and Sustainable Management Group, University of Queensland. [Downloadable!]
  11. Sujoy Mukerji, 2003. "Ambiguity Aversion and Cost-Plus Procurement Contracts," Economics Series Working Papers 171, University of Oxford, Department of Economics. [Downloadable!]
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