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Bounds on the Risk-Free Interest Rate in Incomplete Markets With and Without Utility Functions Exhibiting Constant Absolute Risk Aversion

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  • Chiaki Hara

    (University of Cambridge)

Abstract

In a model of a two-period exchange economy under uncertainty, we find an upper bound for the equilibrium risk-free interest rate when the expected aggregate endowment in the second period is no greater than the first-period aggregate endowment. We also find a lower bound when the agents' utility functions exhibit constant absolute risk aversion and the expected aggregate endowment in the second period is no smaller than the first-period counterpart. These bounds are independent of the degree of market incompleteness, and so these results show to what extent market incompleteness can explain the risk-free rate puzzle in this class of general equilibrium models with heterogeneous agents. A general method of finding lower bounds is also presented.

Suggested Citation

  • Chiaki Hara, 2000. "Bounds on the Risk-Free Interest Rate in Incomplete Markets With and Without Utility Functions Exhibiting Constant Absolute Risk Aversion," Econometric Society World Congress 2000 Contributed Papers 1448, Econometric Society.
    • Handle: RePEc:ecm:wc2000:1448
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    Cited by:

    1. David K. Levine & William R. Zame, 2002. "Does Market Incompleteness Matter?," Econometrica, Econometric Society, vol. 70(5), pages 1805-1839, September.

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