On price uncertainty, nominal assets and uninsurable idiosyncratic risks

Abstract

The paper discusses a way in which price uncertainty may affect the extent of idiosyncratic, uninsurable risks in an incomplete markets economy with nominal assets and thereby affect output and welfare. Although the returns on these assets are constant and riskfree in nominal terms, price uncertainty causes their real returns to be stochastic. This affects the ability of households to diversify their idiosyncratic risks using these assets and consequently the extent of uninsurable risks in the economy. The paper establishes a relationship between the volume of trade in nominal assets, the stochastic characteristics of the price shocks and the covariance between the price and idiosyncratic shocks.