Risk-Free Bond Prices in Incomplete Markets with Recursive Utility Functions and Multiple Beliefs

KIER, Kyoto University Paper No. 590

26 Pages Posted: 28 Sep 2004

See all articles by Chiaki Hara

Chiaki Hara

Kyoto University - Institute of Economic Research

Atsushi Kajii

Institute of Economic Research, Kyoto University; Singapore Management University

Date Written: June 2004

Abstract

We consider an exchange economy under uncertainty, in which agents' utility functions exhibit constant absolute risk aversion, but they may be recursive and the expected utility calculation may be based on multiple subjective beliefs. The risk aversion coefficients, subjective beliefs, subjective time discount factors, initial endowments, and tradeable assets may differ across agents. We prove that the risk-free bond price goes down (and the interest rate goes up) monotonically as the markets become more complete. We find the range of equilibrium bond prices that depends on the primitives of the economy but not on the structures of financial markets.

Keywords: The risk-free rate puzzle, constant absolute risk aversion, incomplete markets

JEL Classification: D52, D91, E21, E44, G12

Suggested Citation

Hara, Chiaki and Kajii, Atsushi, Risk-Free Bond Prices in Incomplete Markets with Recursive Utility Functions and Multiple Beliefs (June 2004). KIER, Kyoto University Paper No. 590, Available at SSRN: https://ssrn.com/abstract=591021 or http://dx.doi.org/10.2139/ssrn.591021

Chiaki Hara

Kyoto University - Institute of Economic Research ( email )

Yoshida-Honmachi
Sakyo-ku
Kyoto 606-8501
Japan

Atsushi Kajii (Contact Author)

Institute of Economic Research, Kyoto University ( email )

Yoshida-Honmachi
Sakyo-ku
Kyoto 606-8501
JAPAN

HOME PAGE: http://www.kier.kyoto-u.ac.jp/~kajii/

Singapore Management University ( email )

School of Economics
90 Stamford Road
Singapore, 178903
Singapore