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On the Range of the Risk-Free Interest Rate in Incomplete Markets

  • Chiaki Hara

    (Faculty of Economics and Politics, University of Cambridge)

  • Atsushi Kajii

    (Institute of Economic Research, Kyoto University)

In a model of a two-period exchange economy under uncertainty, we find both upper and lower bounds for the risk free interest rate when the agents' utility functions exhibit constant absolute risk aversion. These bounds are independent of the degree of market incompleteness, and so in particular these results show to what extent market incompleteness can explain the risk-free rate puzzle in this class of general equilibrium models with heterogeneous agents. A general method of finding these bounds without the assumption of constant absolute risk aversion is also presented.

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File URL: http://www.kier.kyoto-u.ac.jp/DP/DP577.pdf
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Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 577.

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Length: 23 pages
Date of creation: Nov 2003
Date of revision:
Handle: RePEc:kyo:wpaper:577
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Web page: http://www.kier.kyoto-u.ac.jp/eng/index.html
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  1. Demange, G. & Laroque, G., 1992. "Private Information and the Design of Securities," DELTA Working Papers 92-22, DELTA (Ecole normale supérieure).
  2. Rahi Rohit, 1995. "Optimal Incomplete Markets with Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 65(1), pages 171-197, February.
  3. Elul, Ronel, 1997. "Financial innovation, precautionary saving and the risk-free rate," Journal of Mathematical Economics, Elsevier, vol. 27(1), pages 113-131, February.
  4. Weil, Philippe, 1992. "Equilibrium asset prices with undiversifiable labor income risk," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 769-790.
  5. David K. Levine & William Zame, 2001. "Does Market Incompleteness Matter," Levine's Working Paper Archive 78, David K. Levine.
  6. David K Levine & William R Zame, 2000. "Risk Sharing and Market Incompleteness," Levine's Working Paper Archive 2080, David K. Levine.
  7. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March.
  8. Laurent Calvet & Jean-Michel Grandmont & Isabelle Lemaire, 2001. "Aggregation of Heterogenous Beliefs and Asset Pricing in Complete Financial Markets," Working Papers 2001-01, Centre de Recherche en Economie et Statistique.
  9. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
  10. Tyge Nielsen, Lars, 1993. "The expected utility of portfolios of assets," Journal of Mathematical Economics, Elsevier, vol. 22(5), pages 439-461.
  11. Ohashi Kazuhiko, 1995. "Endogenous Determination of the Degree of Market-Incompleteness in Futures Innovation," Journal of Economic Theory, Elsevier, vol. 65(1), pages 198-217, February.
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