The Equilibrium Allocation of Diffusive and Jump Risks with Heterogeneous Agents

Posted: 12 Nov 2004

See all articles by Michael F. Gallmeyer

Michael F. Gallmeyer

University of Virginia (UVA) - McIntire School of Commerce

Stephan Dieckmann

University of Pennsylvania - Finance Department

Abstract

We study a two-agent pure exchange equilibrium subject to both nondiversifiable diffusive and jump risks. Agents can trade in a financial market consisting of a stock market, a money market, and an insurance market for jump risk. Heterogeneity is introduced through different levels of relative risk aversion. In the framework of standard expected utility we find the surprising result that the less risk averse agent purchases insurance contracts against jump risk from the more risk averse agent. This equilibrium allocation is linked to the non-linear wealth sharing rule in such an economy, and preserves the wealth effects studied by Dumas (1989) in the case of pure diffusive risk. Since the benchmark economy with homogenous agents generates no excess uncertainty in the stock market, we study the effect on excess volatility and excess jump size solely due to different levels of relative risk aversion. We observe 3% excess uncertainty in jump sizes for a reasonable specification of economic fundamentals.

Keywords: General Equilibrium, Pure Exchange Economy, Jump-Diffusion Model, Heterogeneous Agents, Excess Uncertainty, Insurance

JEL Classification: D51, G11, G12

Suggested Citation

Gallmeyer, Michael F. and Dieckmann, Stephan, The Equilibrium Allocation of Diffusive and Jump Risks with Heterogeneous Agents. Journal of Economic Dynamics and Control, Forthcoming. Available at SSRN: https://ssrn.com/abstract=646322

Michael F. Gallmeyer

University of Virginia (UVA) - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-243-4043 (Phone)
434-924-7074 (Fax)

HOME PAGE: http://www.commerce.virginia.edu/faculty_research/facultydirectory/Pages/Gallmeyer.aspx

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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