This paper views uncertainty and economic fluctuations as being primarily endogenous and internally propagated phenomena. The most important Endogenous Uncertainty examined in this paper is price uncertainty which arises when agents do not have structural knowledge and are compelled to make decisions on the basis of their beliefs. We assume that agents adopt Rational Beliefs as in Kurz [1994a]. The trading of endogenous uncertainty is accomplished by using Price Contingent Contracts (PCC) rather than the Arrow-Debreu state contingent contracts. The paper provides a full construction of the "price state space" which requires the expansion of the exogenous state space to include the "state of beliefs." This construction is central to the analysis of equilibrium with endogenous uncertainty and the paper provides an existence theorem for a Rational Belief Equilibrium with PCC. It shows how the PCC completes the markets for trading endogenous uncertainty and lead to an allocation which is Pareto optimal. The paper also demonstrates that endogenous uncertainty is generically present in this new equilibrium.

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Paper provided by Stanford University, Department of Economics in its series Working Papers with number 96002.

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Handle: RePEc:wop:stanec:96002

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1. Kurz, Mordecai & Motolese, Maurizio, 2006. "Risk Premia, diverse belief and beauty contests," MPRA Paper 247, University Library of Munich, Germany. [Downloadable!]
2. Carsten Krabbe Nielsen, 2004. "Stabilizing, Pareto Improving Policies in an OLG model with Incomplete Markets: The Rational Expectations and Rational Beliefs Case," Econometric Society 2004 Far Eastern Meetings 617, Econometric Society. [Downloadable!]
3. Mordecai Kurz, 1997. "Social States of Belief and the Determinants of the Equity Risk Premium in A Rational Belief Equilibrium," Working Papers 97026, Stanford University, Department of Economics. [Downloadable!]
4. Kurz, Mordecai, 2006. "Beauty contests under private information and diverse beliefs: how different?," MPRA Paper 233, University Library of Munich, Germany, revised Apr 2006. [Downloadable!]

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