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Endogenous uncertainty in a general equilibrium model with price contingent contracts (*)

Author

Listed:
  • Ho-Mou Wu

    (Department of Economics, National Taiwan University and Institute of Economics, Academia Sinica, 21 Hsu Chow Road, Taipei 10020, TAIWAN)

  • Mordecai Kurz

    (Department of Economics, Serra Street at Galvez, Stanford University, Stanford, CA 94305-6072, USA)

Abstract

This paper views uncertainty and economic fluctuations as being primarily endogenous and internally propagated phenomena. The most important Endogenous Uncertainty examined in this paper is price uncertainty which arises when agents do not have structural knowledge and are complelled to make decisions on the basis of their beliefs. We assume that agents adopt Rational Beliefs as in Kurz [1994a]. The trading of endogenous uncertainty is accomplished by using Price Contingent Contracts (PCC) rather than the Arrow-Debreu state contingent contracts. The paper provides a full construction of the "price state space" which requires the expansion of the exogenous state space to include the "state of beliefs." This construction is central to the analysis of equilibrium with endogenous uncertainty and the paper provides an existence theorem for a Rational Belief Equilibrium with PCC. It shows how the PCC completes the markets for trading endogenous uncertainty and lead to an allocation which is Pareto optimal. This paper also demonstrates that endogenous uncertainty is generically present in this new equilibrium.

Suggested Citation

  • Ho-Mou Wu & Mordecai Kurz, 1996. "Endogenous uncertainty in a general equilibrium model with price contingent contracts (*)," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 8(3), pages 461-488.
    • Handle: RePEc:spr:joecth:v:8:y:1996:i:3:p:461-488
    Note: Received: March 14, 1995; revise version November 9, 1995
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    JEL classification:

    • D5 - Microeconomics - - General Equilibrium and Disequilibrium
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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