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Sharing idiosyncratic risk even though prices are “wrong”

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  • Halim, Edward
  • Riyanto, Yohanes E.
  • Roy, Nilanjan

Abstract

We design an infinite-horizon dynamic asset market experiment with perishable consumption and a long-lived asset where gains from trade originate from individuals experiencing idiosyncratic income shocks. Our study is based on the consumption-based general equilibrium theory (Lucas (1978)). The presence of traders having induced motive to smooth consumption is not sufficient to eliminate price bubbles. Despite the asset being consistently priced higher than the equilibrium price, traders are able to share idiosyncratic risk and attain higher welfare. The co-existence of traders with income shocks along with those having no induced motive to trade does not hinder in the former smoothing their consumption stream. Our results hold for markets with and without aggregate risk.

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  • Halim, Edward & Riyanto, Yohanes E. & Roy, Nilanjan, 2022. "Sharing idiosyncratic risk even though prices are “wrong”," Journal of Economic Theory, Elsevier, vol. 200(C).
    • Handle: RePEc:eee:jetheo:v:200:y:2022:i:c:s0022053121002179
    DOI: 10.1016/j.jet.2021.105400
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    More about this item

    Keywords

    Aggregate risk; Idiosyncratic risk; Asset price bubbles; General equilibrium theory; Consumption smoothing; Experiments;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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