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Asset pricing implications of efficient risk sharing in an endowment economy

  • Pamela Labadie
Part of the Studies in Economic Theory book series (ECON.THEORY, volume 24)

Summary

The asset pricing behavior is studied in an overlapping generations model that is dynamically inefficient because of inefficient aggregate risk sharing. The inefficiency is linked with the stochastic distribution of income over agents within a period. The introduction of a clearing house may eliminate the dynamic inefficiency, but depending on how the clearing house operates, households may only have partial insurance against income risk. Hence, the clearing house affects the marginal rate of substitution (MRS) across generations within a period and also the intertemporal marginal rate of substitution faced by a household, which is the stochastic discount factor (SDF) applied to income streams over time. The opportunity to insure against income risk is related to different concepts of Pareto optimality. The implications for asset prices and the market price of risk are derived. In particular, the matrix of contingent claim prices supporting a Pareto optimal allocation must have a dominant root no greater than unity. This is equivalent to restricting the matrix of within-period MRS to have a dominant root no greater than unity. The sequence of powers of the pricing matrix determines the time series properties of the SDF, asset prices and asset returns.

Keywords

Asset Price Pareto Optimality Competitive Equilibrium Contingent Claim Clearing House 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

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Copyright information

© Springer-Verlag Berlin Heidelberg 2006

Authors and Affiliations

  • Pamela Labadie
    • 1
  1. 1.Department of Economics, 300 Academic BuildingMount Vernon Campus, George Washington UniversityWashington

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