Financial System Risk and Flight to Quality

We present a model of flight to quality episodes that emphasizes financial system risk and the Knightian uncertainty surrounding these episodes. In the model, agents are uncertain about the probability distribution of shocks in markets different from theirs, treating such uncertainty as Knightian. Aversion to this uncertainty generates demand for safe financial claims. It also leads agents to require financial intermediaries to lock-up capital to cover their own markets' shocks in a manner that is robust to uncertainty over other markets. These actions are wasteful in the aggregate and can trigger a financial accelerator. A lender of last resort can unlock private capital markets to stabilize the economy during these episodes by committing to intervene should conditions worsen.

Sustained Output Growth Under Uncertainty: A Simple Model With Human Capital

In a model where agents use their labour/education choice to adjust their consumption profile over time, I show that the impact of uncertainty on growth depends, critically, on agents’ attitudes towards risk, reflected by the coefficient of relative risk aversion. In this respect, the well known result from the literature on ‘saving under uncertainty’ can be extended into a broader context, whereby the intertemporal profile of consumption is determined via human capital accumulation rather than saving and physical capital investment.Growth, Uncertainty

Intertemporal Equilibria with Knightian Uncertainty

We study a dynamic and infinite-dimensional model with Knightian uncertainty modeled by incomplete multiple prior preferences. In interior efficient allocations, agents share a common risk-adjusted prior and use the same subjective interest rate. Interior efficient allocations and equilibria coincide with those of economies with subjective expected utility and priors from the agents' multiple prior sets. We show that the set of equilibria with inertia contains the equilibria of the economy with variational preferences anchored at the initial endowments. A case study in an economy without aggregate uncertainty shows that risk is fully insured, while uncertainty can remain fully uninsured. Pessimistic agents with Gilboa-Schmeidler's max-min preferences would fully insure risk and uncertainty.Knightian Uncertainty, Ambiguity, Incomplete Preferences, General Equilibrium Theory, No Trade

Prudent Expectations Equilibrium in Economies with Uncertain Delivery

In an economy with private information, we introduce the notion of objects of choice as lists of bundles out of which the market selects one for delivery. This leads to an extension of the model of Arrow-Debreu that is used to study ex-ante trade with private state verification. The model does not require agents to have complete information about the space of states, being suited to a context of Knightian uncertainty. Under the assumption that agents are prudent, equilibrium is characterized by the fact that agents consume bundles with the same utility in states that they do not distinguish.General equilibrium, Private information, Incomplete information, Knightian uncertainty, Ambiguity, Uncertain delivery, Lists of bundles.

International trade, hedging and the demand for forward contracts

There is a huge literature on the effects of uncertainty on trade levels. One very strong result of that literature is that uncertainty should not matter, as long as well developed forward markets exist. The empirical implications of this result, however, are hard to find in the data. We model terms of trade uncertainty in a small open economy with uncertainty stemming from abroad and derive the equilibrium demand for forward contracts. It turns out that risk averse agents will not buy forwards at an actuarially fair price, thus rendering both the full-hedge theorem and the separation theorem of the aforementioned literature obsolete. Using real world data for Germany we calibrate our model. We find that in equilibrium risk averse agents will buy forward cover only for nvestment reasons. The amount of forwards purchased is around 20% of equilibrium imports. This is broadly in accordance with empirical observed ratios. --forward contracts,terms of trade uncertainty,hedging

Conflict and Uncertainty: A Dynamic Approach

Most of the conflict theory papers have used a one-shot game set-up. This does not correspond to reality and is certainly incapable of modeling real conflict situations. We propose a dynamic model with N-agents in an infinite time frame which allow us to adequately analyze conflicts. The dynamic aspects of the conflict come at least from two sources: first, the preferences on the good in dispute are not static; second, agentsin conflict can influence the future of the conflict by making investment in conflict's technology. We use a simple deterministic rule that defines the evolution of the subjective valuation for the good in dispute according to the results obtained by the agents in the recent past. During each period the realization of stochastic variables of the nature's states induces uncertainty in the game. The model is a theoretical approach that can be applied to evaluate the role of uncertainty and valuations' evolution on the optimal choices of forward-looking economic agents that seek to appropriate a share of a divisible resource.Conflict Theory, Dynamic Economic Model, Uncertainty

International Trade, Hedging and the Demand for Forward Contracts

There is a huge literature on the effects of uncertainty on trade levels. One very strong result of that literature is that uncertainty should not matter, as long as well developed forward markets exist. The empirical implications of this result, however, are hard to find in the data. We model terms of trade uncertainty in a small open economy with uncertainty stemming from abroad and derive the equilibrium demand for forward contracts. It turns out that risk averse agents will not buy forwards at an actuarially fair price, thus rendering both the full-hedge theorem and the separation theorem of the afore-mentioned literature obsolete. Using real world data for Germany we calibrate our model. We find that in equilibrium risk averse agents will buy forward cover only for investment reasons. The amount of forwards purchased is around 20% of equilibrium imports. This is broadly in accordance with empirical observed ratios.