Journal Article

Ambiguity Aversion and Incompleteness of Financial Markets

Sujoy Mukerji and Jean-Marc Tallon

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 68, issue 4, pages 883-904
Published in print October 2001 | ISSN: 0034-6527
Published online October 2001 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/1467-937X.00194
Ambiguity Aversion and Incompleteness of Financial Markets

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It is widely thought that incomes risks can be shared by trading in financial assets. But financial assets typically carry some risk idiosyncratic to them, hence, disposing incomes risk using financial assets will involve buying into the inherent idiosyncratic risk. However, standard theory argues that diversification would reduce the inconvenience of idiosyncratic risk to arbitrarily low levels. This paper shows that this argument is not robust: ambiguity aversion can exacerbate the tension between the two kinds of risks to the point that classes of agents may not want to trade some financial assets. Thus, theoretically, the effect of ambiguity aversion on financial markets is to make the risk sharing opportunities offered by financial markets less complete than it would be otherwise.

Journal Article.  0 words. 

Subjects: Economics

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