Australasian Microeconomic Theory Seminar - John Quiggin (UQ)

Title:  Financial Market Equilibrium with Bounded

Abstract:  We consider an inÖnite-horizon economy with di§erential awareness. For such economies, we propose an equilibrium concept which requires agentsí consumption to be measurable with respect to the individual awareness partitions. We illustrate how the obtained equilibrium allocations observationally di§er from those in economies with full awareness. In particular, economies with di§erential awareness can exhibit (i) lack of insurance against idiosyncratic risk; (ii) partial insurance against aggregate risk; (iii) biased state prices even when beliefs are correct and (iv) overpricing of assets which pay on events with low aggregate payo§s. We next adapt the results of Guerdjikova and Quiggin (2019 a) to show that agents with di§erent levels of awareness can survive and ináuence prices in the limit. Moreover, di§erential awareness can lead to belief heterogeneity even in the limit. This is in contrast with the classical result of Blume and Easley (2006) stating that only agents with beliefs closest to the truth can survive. Finally, we examine the welfare implications of bounded awareness. If an increase in awareness comes at the cost of wrong beliefs over the larger state-space, bounded awareness can be welfare-improving, both from an individual and from a social point of view.