THIS PAPER IS A THEORETICAL examination of the stochastic behavior of equilibrium asset prices in a one-good, pure exchange economy with identical consumers. The single good in this economy is (costlessly) produced in a number of different productive units; an asset is a claim to all or part of the output of one of these units. Productivity in each unit fluctuates stochastically through time, so that equilibrium asset prices will fluctuate as well. Our objective will be to understand the relationship between these exogenously determined productivity changes and market determined movements in asset prices. Most of our attention will be focused on the derivation and application of a functional equation in the vector of equilibrium asset prices, which is solved for price as a function of the physical state of the economy. This equation is a generalization of the Martingale property of stochastic price sequences, which serves in practice as the defining characteristic of market "efficiency," as that term is used by Fama [7] and others. The model thus serves as a simple context for examining the conditions under which a price series' failure to possess the Martingale property can be viewed as evidence of non-competitive or "irrational" behavior. The analysis is conducted under the assumption that, in Fama's terms, prices "fully reflect all available information," an hypothesis which Muth [13] had earlier termed "rationality of expectations." As Muth made clear, this hypothesis (like utility maximization) is not "behavioral": it does not describe the way agents think about their environment, how they learn, process information, and so forth. It is rather a property likely to be (approximately) possessed by the outcome of this unspecified process of learning and adapting. One would feel more comfortable, then, with rational expectations equilibria if these equilibria were accompanied by some form of "stability theory" which illuminated the forces which move an economy toward equilibrium. The present paper also offers a convenient context for discussing this issue. The conclusions of this paper with respect to the Martingale property precisely replicate those reached earlier by LeRoy (in [10] and [11]), and not surprisingly, since the economic reasoning in [10] and the present paper is the same. The

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Aspects of the Theory of Risk Bearing--Yrjo Jahnsson Lectures

Asset prices in an exchange economy

This book updates and advances the theory of expected utility as applied to risk analysis and financial decision making. Von Neumann and Morgenstern pioneered the use of expected utility theory in the 1940s, but most utility functions used in financial management are still relatively simplistic and assume a mean-variance world. Taking into account recent advances in the economics of risk and uncertainty, this book focuses on richer applications of expected utility in finance, macroeconomics, and environmental economics. The book covers these topics: expected utility theory and related concepts; the standard portfolio problem of choice under uncertainty involving two different assets; P the basic hyperplane separation theorem and log-supermodular functions as technical tools for solving various decision-making problems under uncertainty; s choice involving multiple risks; the Arrow-Debreu portfolio problem; consumption and saving; the equilibrium price of risk and time in an Arrow-Debreu economy; and dynamic models of decision making when a flow of information on future risks is expected over time. The book is appropriate for both students and professionals. Concepts are presented intuitively as well as formally, and the theory is balanced by empirical considerations. Each chapter concludes with a problem set.

background or methods

/pdf/the-economics-of-risk-and-time-3rtoqtauhe.pdf

The economics of risk and time

"Expected Utility" Analysis without the Independence Axiom

Problems concerned with purchasing of insurance coverage appear to be a fascinating and potentially fruitful field for application and testing of theories of riskbearing. In this note we shall analyze a series of such problems from the point of view of an individual facing certain risks. Given his risk situation and his economic background (as measured by his initial wealth), his problem is to decide whether he should provide for in­surance coverage and, if so, how much.

https://www.jstor.org/stable/info/1830049

Aspects of Rational Insurance Purchasing

The common folklore that giving options to agents will make them more willing to take risks is false. In fact, no incentive schedule will make all expected utility maximizers more or less risk averse. This paper finds simple, intuitive, necessary and sufficient conditions under which incentive schedules make agents more or less risk averse. The paper uses these to examine the incentive effects of some common structures such as puts and calls, and it briefly explores the duality between a fee schedule that makes an agent more or less risk averse, and gambles that increase or decrease risk. WITH THE GROWING INTEREST in executive compensation and agency problems,

/pdf/compensation-incentives-and-the-duality-of-risk-aversion-and-10ru4ar7k0.pdf

Aspects of the Theory of Risk Bearing--Yrjo Jahnsson Lectures

Citations

Asset prices in an exchange economy

The economics of risk and time

"Expected Utility" Analysis without the Independence Axiom

Aspects of Rational Insurance Purchasing

Compensation, Incentives, and the Duality of Risk Aversion and Riskiness

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