Assessing Welfare in Models with Heterogeneous Beliefs

41 Pages Posted: 13 Nov 2011 Last revised: 12 Jun 2012

See all articles by Jeong Ho (John) Kim

Jeong Ho (John) Kim

Florida State University - Department of Finance

Date Written: April 10, 2012

Abstract

In models with heterogeneous beliefs, we cannot analyze policy interventions using standard methods of welfare economics. We develop a novel way of assessing welfare in such models, building on risk sharing rather than the Pareto property as the concept of efficiency. Differences of opinion engender speculative motives that frustrate risk sharing and encourage self-destructive betting. In particular, unregulated competitive equilibria in the presence of belief heterogeneity cause excessive risk-taking and insufficient risk sharing in terms of social welfare. Our analysis calls for strict regulations of fi…nancial markets cursed by belief divergences, such as the controversial naked credit default swaps.

Suggested Citation

Kim, Jeong Ho, Assessing Welfare in Models with Heterogeneous Beliefs (April 10, 2012). Available at SSRN: https://ssrn.com/abstract=1958706 or http://dx.doi.org/10.2139/ssrn.1958706

Jeong Ho Kim (Contact Author)

Florida State University - Department of Finance ( email )

Tallahassee, FL 32306-1042
United States

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