Radner Equilibrium in Incomplete Levy Models

Abstract

We construct continuous-time equilibrium models based on a finite number of exponential utility investors. The investors' income rates as well as the stock's dividend rate are governed by discontinuous Levy processes. Our main result provides the equilibrium (i.e., bond and stock price dynamics) in closed-form. As an application, we show that the equilibrium Sharpe ratio can be increased and the equilibrium interest rate can be decreased (simultaneously) when the investors' income streams cannot be traded.

Keywords: Unspanned income, heterogeneous exponential utilities, continuous-time equilibrium, risk-free rate puzzle, equity premium puzzle, Sharpe ratio, Levy processes

JEL Classification: G12, G11, D53