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Economic Theory

, Volume 62, Issue 3, pp 517–545 | Cite as

Incomplete markets and derivative assets

  • François Le Grand
  • Xavier RagotEmail author
Research Article

Abstract

We analyze derivative asset trading in an economy in which agents face both aggregate and uninsurable idiosyncratic risks. Insurance markets are incomplete for idiosyncratic risk and, possibly, for aggregate risk as well. However, agents can exchange insurance against aggregate risk through derivative assets such as options. We present a tractable framework, which allows us to characterize the extent of risk sharing in this environment. We show that incomplete insurance markets can explain some properties of the volume of traded derivative assets, which are difficult to explain in complete market economies.

Keywords

Incomplete markets Heterogeneous agent models Imperfect risk sharing Derivative assets 

JEL Classification

G1 G12 E44 

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Copyright information

© Springer-Verlag Berlin Heidelberg 2015

Authors and Affiliations

  1. 1.Paris School of Economics-CNRS and OFCEParisFrance
  2. 2.EMLyon Business SchoolÉcullyFrance

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