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Construction of a State Space for Interrelated Securities with an Application to Temporary Equilibrium Theory

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  • Henrotte, Philippe

Abstract

We construct an endogenous state space in an exchange economy with possibly infinite horizon. Every period, agents trade securities whose payoffs depend on future dividends and asset prices. We reject the perfect foresight assumption on the grounds that agents have not only limited knowledge of other individuals' endowments and preferences but also limited capacity to compute equilibria. We choose instead, absence of arbitrage as the principle which allows agents to determine if a system of future prices is possible. We give an algorithm to compute the set of nonarbitrage prices every period with both finite and infinite horizon. We then apply this endogenous structure of uncertainty to an infinite horizon temporary equilibrium model.

Suggested Citation

  • Henrotte, Philippe, 1996. "Construction of a State Space for Interrelated Securities with an Application to Temporary Equilibrium Theory," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 8(3), pages 423-459, October.
  • Handle: RePEc:spr:joecth:v:8:y:1996:i:3:p:423-59
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    Cited by:

    1. Charalambos Aliprantis & Donald J. Brown & Werner, J., 1997. "Incomplete Derivative Markets and Portfolio Insurance," Cowles Foundation Discussion Papers 1126R, Cowles Foundation for Research in Economics, Yale University.
    2. 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.
    3. Aliprantis, C. D. & Brown, D. J. & Werner, J., 2000. "Minimum-cost portfolio insurance," Journal of Economic Dynamics and Control, Elsevier, vol. 24(11-12), pages 1703-1719, October.

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