Endogenous Uncertainty in a General Equilibrium Model with Price Contingent Contracts

ECONOMIC THEORY, Vol. 8, No. 3, November 1996

Posted: 5 Feb 1997

See all articles by Mordecai Kurz

Mordecai Kurz

Stanford University - Department of Economics

Ho-Mou Wu

National Taiwan University - Department of International Business

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Abstract

This paper views uncertainty and economic fluctuations as being primarily endogenous and internally propagated phenomena. The most important Endogenous Uncertainty examined in this paper is price uncertainty which arises when agents do not have structural knowledge and are compelled to make decisions on the basis of their beliefs. We assume that agents adopt Rational Beliefs as in Kurz [1994a]. The trading of endogenous uncertainty is accomplished by using Price Contingent Contracts (PCC) rather than the Arrow-Debreu state contingent contracts. The paper provides a full construction of the "price state space" which requires the expansion of the exogenous state space to include the "state of beliefs." This construction is central to the analysis of equilibrium with endogenous uncertainty and the paper provides an existence theorem for a Rational Belief Equilibrium with PCC. It shows how the PCC completes the markets for trading endogenous uncertainty and lead to an allocation which is Pareto optimal. The paper also demonstrates that endogenous uncertainty is generically present in this new equilibrium.

JEL Classification: D5, D84, G13

Suggested Citation

Kurz, Mordecai and Wu, Ho-Mou, Endogenous Uncertainty in a General Equilibrium Model with Price Contingent Contracts. ECONOMIC THEORY, Vol. 8, No. 3, November 1996, Available at SSRN: https://ssrn.com/abstract=3700

Mordecai Kurz (Contact Author)

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States

Ho-Mou Wu

National Taiwan University - Department of International Business ( email )

50, Lane 144, Section 4, Keelung Road
Taipei 106
Taiwan

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