Ambiguity Aversion and Incompleteness of Financial Markets

Posted: 21 Sep 2001

See all articles by Sujoy Mukerji

Sujoy Mukerji

Queen Mary University of London; International Centre for Economic Research (ICER)

Jean-Marc Tallon

Paris School of Economics

Abstract

It is widely thought that incomes risks can be shared by trading in financial assets. But financial assets typically carry some risk idiosyncratic to them, hence, disposing incomes risk using financial assets will involve buying into the inherent idiosyncratic risk. However, standard theory argues that diversification would reduce the inconvenience of idiosyncratic risk to arbitrarily low levels. This paper shows that this arument is not robust: ambiguity aversion can exacerbate the tension between the two kinds of risks to the point that classes of agents may not want to trade some financial assets. Thus, theoretically, the effect of ambiguity aversion on financial markets is to make the risk sharing opportunities offered by financial markets less complete than it would be otherwise.

Keywords: Ambiguity aversion, incomplete markets, sub-optimal risk sharing.

JEL Classification: D81, D52

Suggested Citation

Mukerji, Sujoy and Tallon, Jean-Marc, Ambiguity Aversion and Incompleteness of Financial Markets. Available at SSRN: https://ssrn.com/abstract=257969

Sujoy Mukerji (Contact Author)

Queen Mary University of London ( email )

Mile End
Mile End Road
London, London E1 4NS
United Kingdom

International Centre for Economic Research (ICER)

Villa Gualino
Viale Settimio Severo, 63
10133 Torino
Italy

Jean-Marc Tallon

Paris School of Economics ( email )

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
1,065
PlumX Metrics