Facoltà di scienze economiche

Optimal decision-making with time diversification

Vanini, Paolo ; Vignola, Luigi

In: European Finance Review, 2002, vol. 6, p. 1-30

One of the most enduring topics in financial theory is the persistence of investment risk across time. Traditional finance lacks methods for considering and hedging non-diversifiable risks. This paper is based on the general equilibrium model of Allen and Gale (1997). We extend their model in various directions: the intermediary is a firm and not a planner, financial markets are assumed to be... More

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    Summary
    One of the most enduring topics in financial theory is the persistence of investment risk across time. Traditional finance lacks methods for considering and hedging non-diversifiable risks. This paper is based on the general equilibrium model of Allen and Gale (1997). We extend their model in various directions: the intermediary is a firm and not a planner, financial markets are assumed to be incomplete, and the mechanism of intergenerational risk-sharing is endogenously determined. Our model allows for the analysis of optimal behavior of individuals and the intermediary together with the respective feedback processes.