Rare Event Risk and Heterogeneous Beliefs: The Case of Incomplete Markets

46 Pages Posted: 10 Jan 2005 Last revised: 8 Apr 2011

See all articles by Stephan Dieckmann

Stephan Dieckmann

University of Pennsylvania - Finance Department

Date Written: November 5, 2009


This paper provides an equilibrium model subject to heterogeneous beliefs about the likelihood of rare events. I explore asset pricing implications in an incomplete capital market and the effects of market completion. Without explicit rare event insurance, investors insure themselves indirectly through the stock and money markets, the risk premium is countercyclical, and flight to quality effects arise. Upon market completion, the risk premium increases as investors increase their exposure to rare event risk. While market completion leads to a more efficient allocation based on investors' anticipatory utilities, its effect on ex-post efficiency is ambiguous.

Keywords: Rare Event Risk, Heterogeneous Beliefs, Incomplete Markets, Catastrophe Insurance, Exchange Economy

JEL Classification: D51, D52, G11, G12, G13

Suggested Citation

Dieckmann, Stephan, Rare Event Risk and Heterogeneous Beliefs: The Case of Incomplete Markets (November 5, 2009). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming, Available at SSRN: https://ssrn.com/abstract=646321

Stephan Dieckmann (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

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