Uncertainty and Risk in Financial Markets
AbstractThis paper considers a general equilibrium model in which the=20 distinction between un-certainty and risk is formalized by assuming agents= =20 have incomplete preferences over state-contingent consumption bundles, as=20 in Bewley (1986). Without completeness, individual decision making depends= =20 on a set of probability distributions over the state space. A bundle is=20 preferred to another if and only if it has larger expected utility for all= =20 probabilities in this set. When preferences are complete this set is a=20 singleton, and the model reduces to standard expected utility. In this=20 setting, we characterize Pareto optima and equilibria, and show that the=20 presence of uncertainty generates robust indeterminacies in equilibrium=20 prices and allocations for any speci=AFcation of initial endowments. We=20 derive comparative statics results linking the degree of uncertainty with=20 changes in equilibria. Despite the presence of robust indeterminacies, we=20 show that equilibrium prices and allocations vary continuously with=20 underlying fundamentals. Equilibria in a standard risk economy are thus=20 robust to adding small degrees of uncertainty. Finally, we give conditions= =20 under which some assets are not traded due to uncertainty aversion.
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Bibliographic InfoPaper provided by EconWPA in its series Game Theory and Information with number 0201001.
Length: 52 pages
Date of creation: 04 Jan 2002
Date of revision:
Note: 52 pages, Acrobat .pdf
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Other versions of this item:
- Rigotti, Luca & Shannon, Chris, 2001. "Uncertainty and Risk in Financial Markets," Department of Economics, Working Paper Series qt6m42r5rr, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
- Rigotti, Luca & Shannon, Chris, 2001. "Uncertainty and Risk in Financial Markets," Department of Economics, Working Paper Series qt7pp7113z, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
- D0 - Microeconomics - - General
- D5 - Microeconomics - - General Equilibrium and Disequilibrium
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
This paper has been announced in the following NEP Reports:
- NEP-ALL-2002-01-22 (All new papers)
- NEP-FMK-2002-01-22 (Financial Markets)
- NEP-MFD-2002-01-22 (Microfinance)
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