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One-fund separation in incomplete markets with two assets

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  • Won, Dong Chul

Abstract

This paper provides a necessary and sufficient condition for one-fund separation to occur in incomplete-market economies where finitely many agents with distinct risk aversion and heterogeneous beliefs are allowed to trade two assets. The condition involves joint restrictions on risk aversion, beliefs and asset payoffs. Thus, such joint restrictions may be indispensable for fund separation in incomplete markets, which is in contrast with the preference-based and return-distribution-based approaches. When the condition for one-fund separation holds, agents could behave in equilibrium as if there were a single fund which delivers the aggregate asset payoffs in the economy. Otherwise, agents choose optimal shares in distinct proportions.

Suggested Citation

  • Won, Dong Chul, 2018. "One-fund separation in incomplete markets with two assets," Finance Research Letters, Elsevier, vol. 24(C), pages 168-174.
  • Handle: RePEc:eee:finlet:v:24:y:2018:i:c:p:168-174
    DOI: 10.1016/j.frl.2017.09.003
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    References listed on IDEAS

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    1. Stephen A. Ross, 2005. "Mutual Fund Separation in Financial Theory—The Separating Distributions," World Scientific Book Chapters,in: Theory Of Valuation, chapter 10, pages 309-356 World Scientific Publishing Co. Pte. Ltd..
    2. Schmedders, Karl, 2007. "Two-fund separation in dynamic general equilibrium," Theoretical Economics, Econometric Society, vol. 2(2), June.
    3. JÊrÆme B. Detemple & Piero Gottardi, 1998. "Aggregation, efficiency and mutual fund separation in incomplete markets," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 11(2), pages 443-455.
    4. Cass, David & Stiglitz, Joseph E., 1970. "The structure of investor preferences and asset returns, and separability in portfolio allocation: A contribution to the pure theory of mutual funds," Journal of Economic Theory, Elsevier, vol. 2(2), pages 122-160, June.
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    More about this item

    Keywords

    One-fund separation; Incomplete markets; Heterogeneous beliefs; Risk aversion;

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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