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Incomplete markets and derivative assets

Author

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  • François Grand

    (EMLyon Business School)

  • Xavier Ragot

    () (Paris School of Economics-CNRS and OFCE)

Abstract

Abstract We analyze derivative asset trading in an economy in which agents face both aggregate and uninsurable idiosyncratic risks. Insurance markets are incomplete for idiosyncratic risk and, possibly, for aggregate risk as well. However, agents can exchange insurance against aggregate risk through derivative assets such as options. We present a tractable framework, which allows us to characterize the extent of risk sharing in this environment. We show that incomplete insurance markets can explain some properties of the volume of traded derivative assets, which are difficult to explain in complete market economies.

Suggested Citation

  • François Grand & Xavier Ragot, 2016. "Incomplete markets and derivative assets," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(3), pages 517-545, August.
  • Handle: RePEc:spr:joecth:v:62:y:2016:i:3:d:10.1007_s00199-015-0912-9
    DOI: 10.1007/s00199-015-0912-9
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    References listed on IDEAS

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    More about this item

    Keywords

    Incomplete markets; Heterogeneous agent models; Imperfect risk sharing; Derivative assets;

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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