Construction of a State Space for Interrelated Securities with an Application to Temporary Equilibrium Theory
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.
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Volume (Year): 8 (1996)
Issue (Month): 3 (October)
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