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Ambiguity Aversion and the Absence of Indexed Debt

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  • Sujoy Mukerji
  • Jean-Marc Tallon

Abstract

If agent`s (subjective) beliefs are ambiguous then the beliefs may not be represented by a unique probability distribution in the standard Bayesian fashion but instead by a set of probabilities. Roughly put, an ambiguity averse decision maker evaluates an act by the minimum expected value that may be associated with it. Inspite of wide and long-standing support among economists for indexation of loan contracts there has been relatively little use of indexation, except in situations of extremely high inflation. The object of this paper is to provide a (theoretical) explanation for this puzzling phenomenon based on the hypothesis that economic agents are ambiguity averse. The present paper considers a competitive general equilibrium model of goods, money and bond markets populated by agents with Choquet expected utility preferences, where both nominal and indexed bonds are available for trade and prices of all goods and bonds are determined endogenously. We obtain conditions which promote an endogenous cessation of trade in indexed bonds: i.e., conditions under which there is no trade in indexed bonds in any equilibrium; only nominal bonds are traded.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 28.

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Date of creation: 01 Oct 2000
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Handle: RePEc:oxf:wpaper:28

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Keywords: Choquet expected utility; ambiguity aversion; Knightian uncertainty; contracts; indexed bonds; indexation;

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Cited by:
  1. Sujoy Mukerji & Jean-Marc Tallon, 2002. "Ambiguity Aversion and the Absence of Wage Indexation," Economics Series Working Papers 111, University of Oxford, Department of Economics.
  2. repec:hal:journl:halshs-00174562 is not listed on IDEAS
  3. Shin-ichi Fukuda, 2012. "Infrequent Changes of the Policy Target: Robust Optimal Monetary Policy under Ambiguity," CARF F-Series, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo CARF-F-295, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  4. Verónica Balzarotti, 2006. "Real Interest Rate Risk in the Argentine Banking System. A Measuring Model," BCRA Working Paper Series 200606, Central Bank of Argentina, Economic Research Department.
  5. Larry G. Epstein & Martin Schneider, 2010. "Ambiguity and Asset Markets," NBER Working Papers 16181, National Bureau of Economic Research, Inc.
  6. Martin Schneider, 2010. "The Research Agenda: Martin Schneider on Multiple Priors Preferences and Financial Markets," EconomicDynamics Newsletter, Review of Economic Dynamics, Review of Economic Dynamics, vol. 11(2), April.
  7. 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 165, University of Oxford, Department of Economics.
  8. Martin Cincibuch & Matrina Horníková, 2008. "Measuring the Financial Markets’ Perception of EMU Enlargement: The Role of Ambiguity Aversion," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, Charles University Prague, Faculty of Social Sciences, vol. 58(05-06), pages 210-230, August.
  9. Mukerji, Sujoy & Tallon, Jean-Marc, 2003. "Ellsberg's two-color experiment, portfolio inertia and ambiguity," Journal of Mathematical Economics, Elsevier, vol. 39(3-4), pages 299-316, June.

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