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Belief-neutral efficiency in financial markets

Author

Listed:
  • Beißner, Patrick

    (Center for Mathematical Economics, Bielefeld University)

  • Riedel, Frank

    (Center for Mathematical Economics, Bielefeld University)

Abstract

Heterogeneous beliefs among market participants can lead to questionable speculative trading that goes beyond any risk-sharing motives. We demonstrate that such unwarranted betting behavior in market equilibrium can be mitigated by introducing nonlinear pricing for ambiguous contracts, without compromising legitimate risk-hedging activities. While Arrow-Debreu equilibria generally fail to achieve belief-neutral efficiency, we establish a modified version of the first welfare theorem in which equilibria with nonlinear prices uphold belief-neutral efficiency. Moreover, we show that belief-neutral efficiency can be ensured by introducing suitable transaction costs for ambiguous financial assets.

Suggested Citation

  • Beißner, Patrick & Riedel, Frank, 2025. "Belief-neutral efficiency in financial markets," Center for Mathematical Economics Working Papers 702, Center for Mathematical Economics, Bielefeld University.
    • Handle: RePEc:bie:wpaper:702
    as

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    File URL: https://pub.uni-bielefeld.de/download/3001086/3001087
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    References listed on IDEAS

    as
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    2. Markus K. Brunnermeier & Alp Simsek & Wei Xiong, 2014. "A Welfare Criterion For Models With Distorted Beliefs," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 129(4), pages 1753-1797.
    3. Terrance Odean., 1996. "Volume, Volatility, Price and Profit When All Trader Are Above Average," Research Program in Finance Working Papers RPF-266, University of California at Berkeley.
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    7. repec:bla:jfinan:v:53:y:1998:i:6:p:1887-1934 is not listed on IDEAS
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