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Markets with endogenous uncertainty: theory and policy

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  • Chichilnisky, Graciela

Abstract

Classic formulations of markets regard uncertainty as originating from acts of nature. I extend this to a formulation of markets which face risks induces by the economy itself, such as the environmental risks of atmospheric and climate change induced by CFC and CO2 emissions. I formulate and prove the existence of a general competitive equilibrium where the state space and the probabilities of events are endogenously determines as part of the equilibrium. Traders take optimal positions with respect to the uncertainty which their own actions induce. The equilibrium allocations are efficient in a restricted sense. I show that scientific uncertainty can be fully hedged. However uncertainty induced by the unknown level of output at an equilibrium cannot be hedged fully. I discuss applications for CAT Futures, recently introduced on the Chicago Board of Trade, and to international environmental strategies.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 8612.

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Date of creation: 1996
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Handle: RePEc:pra:mprapa:8612

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Keywords: endogenous uncertainty; markets general equilibrium; financial innovation; CAT futures;

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References

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  1. Hahn, F., 1992. "Incomplete Market Economy," Papers 166, Cambridge - Risk, Information & Quantity Signals.
  2. Chichilnisky, Graciela, 1977. "Spaces of economic agents," Journal of Economic Theory, Elsevier, vol. 15(1), pages 160-173, June.
  3. Chichilnisky, G. & Heal, G., 1993. "Global Environmental Risks," Discussion Papers 1993_03, Columbia University, Department of Economics.
  4. Chichilnisky Graciela & Heal Geoffrey M., 1993. "Competitive Equilibrium in Sobolev Spaces without Bounds on Short Sales," Journal of Economic Theory, Elsevier, vol. 59(2), pages 364-384, April.
  5. Chichilnisky, G, 1996. "A Unified perspective on Resource Allocation : Limited Arbitrage is Necessary and Sufficient for the Existence of a Competitive Equilibrium, the Core and Social Choice," Discussion Papers 1996_29, Columbia University, Department of Economics.
  6. Drew Fudenberg & Bengt Holmstrom & Paul Milgrom, 1987. "Short-Term Contracts and Long-Term Agency Relationships," Working papers 468, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Stein, Jerome L, 1992. "Price Discovery Processes," The Economic Record, The Economic Society of Australia, vol. 0(0), pages 34-45, Supplemen.
  8. Ellickson,Bryan, 1994. "Competitive Equilibrium," Cambridge Books, Cambridge University Press, number 9780521319881, October.
  9. Chichilnisky, G. & Heal, G. & Strueffer, P.A. & Swinkels, J.M., 1993. "Beleiving in Multiple Equilibria," Discussion Papers 1993_22, Columbia University, Department of Economics.
  10. Chichilnisky, Graciela, 1997. "Limited arbitrage is necessary and sufficient for the existence of an equilibrium," Journal of Mathematical Economics, Elsevier, vol. 28(4), pages 470-479, November.
  11. Chichilnisky, G., 1992. "Existence and Optimality of a General Equilibrium with Endogenous Uncertainty," Papers 93-11, Columbia - Graduate School of Business.
  12. Cass, David & Chichilnisky, Graciela & Wu, Ho-Mou, 1996. "Individual Risk and Mutual Insurance," Econometrica, Econometric Society, vol. 64(2), pages 333-41, March.
  13. Wilson, Robert, 1992. "Strategic analysis of auctions," Handbook of Game Theory with Economic Applications, in: R.J. Aumann & S. Hart (ed.), Handbook of Game Theory with Economic Applications, edition 1, volume 1, chapter 8, pages 227-279 Elsevier.
  14. Chichilnisky, Graciela, 1994. "Social Diversity, Arbitrage, and Gains from Trade: A Unified Perspective on Resource Allocation," American Economic Review, American Economic Association, vol. 84(2), pages 427-34, May.
  15. repec:fth:coluec:645 is not listed on IDEAS
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Citations

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Cited by:
  1. Chichilnisky, Graciela, 1998. "The economics of global environmental risk," MPRA Paper 8812, University Library of Munich, Germany.
  2. Chichilnisky, Graciela & Wu, Ho-Mou, 2006. "General equilibrium with endogenous uncertainty and default," Journal of Mathematical Economics, Elsevier, vol. 42(4-5), pages 499-524, August.
  3. Cornelis A. Los, 2004. "Measuring Financial Cash Flow and Term Structure Dynamics," Finance 0409046, EconWPA.
  4. Chichilnisky, Graciela & Heal, Geoffrey, 1998. "Managing unknown risks: the future of global reinsurance," MPRA Paper 8820, University Library of Munich, Germany.

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