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A two-person dynamic equilibrium under ambiguity

  • Epstein, Larry G.
  • Miao, Jianjun

This paper describes a pure-exchange, continuous-time economy with two heterogeneous agents and complete markets. A novel feature of the economy is that agents perceive some security returns as ambiguous in the sense often attributed to frank Knight. The equilibrium is described completely in closed-form. In particular, closed-form solutions are obtained for the equilibrium processes describing individual consumption, the interest rate, the market price of uncertainty, security prices and trading strategies. After identifying agents as countries, the model is applied to address the consumption home-bias puzzles.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 27 (2003)
Issue (Month): 7 (May)
Pages: 1253-1288

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Handle: RePEc:eee:dyncon:v:27:y:2003:i:7:p:1253-1288
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  8. Dumas, Bernard, 1989. "Two-Person Dynamic Equilibrium in the Capital Market," Review of Financial Studies, Society for Financial Studies, vol. 2(2), pages 157-88.
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  16. Duffie, Darrell & Epstein, Larry G, 1992. "Asset Pricing with Stochastic Differential Utility," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 411-36.
  17. Duffie, Darrell & Epstein, Larry G, 1992. "Stochastic Differential Utility," Econometrica, Econometric Society, vol. 60(2), pages 353-94, March.
  18. Larry G. Epstein & Martin Schneider, 2001. "Recursive Multiple-Priors," RCER Working Papers 485, University of Rochester - Center for Economic Research (RCER).
  19. Zengjing Chen & Larry G. Epstein, 2000. "Ambiguity, risk and asset returns in continuous time," RCER Working Papers 474, University of Rochester - Center for Economic Research (RCER).
  20. Kenneth R. French & James M. Poterba, 1991. "Investor Diversification and International Equity Markets," NBER Working Papers 3609, National Bureau of Economic Research, Inc.
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  23. Zapatero, Fernando, 1998. "Effects of financial innovations on market volatility when beliefs are heterogeneous," Journal of Economic Dynamics and Control, Elsevier, vol. 22(4), pages 597-626, April.
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