Market selection when markets are incomplete

Alvaro Sandroni*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

21 Scopus citations

Abstract

Consider a two period exchange economy with dividend uncertainty. Agents have different beliefs, endowments and utility functions. This results in different motives for trading, such as risk-sharing and speculation. In the first period agents trade Arrow securities in zero supply. The set of available Arrow securities is of a specific form, but it can be complete or incomplete. In the second period one out of many possible states of nature is realized. I show that agents with more accurate beliefs (in the sense of higher market entropy) will accumulate more wealth and therefore dominate the economy. This holds regardless of agents' preferences over risk and in both complete and incomplete market economies. These results indicate that belief accuracy rather than preferences over risk is the critical factor determining survival. However, the exact sense in which agents with more accurate beliefs become wealthier is stronger in complete market economies than in incomplete market economies.

Original languageEnglish (US)
Pages (from-to)91-104
Number of pages14
JournalJournal of Mathematical Economics
Volume41
Issue number1-2
DOIs
StatePublished - Feb 2005

Keywords

  • Entropy
  • Market
  • Selection

ASJC Scopus subject areas

  • Economics and Econometrics
  • Applied Mathematics

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