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Abstract

We now go on to analyze the simplest possible equilibrium model. Unlike the previous chapter, where we studied individual consumption and portfolio choices while taking prices as given, in this chapter our goal will be to solve for the equilibrium prices of assets in the economy. In particular, we will be able to derive the equilibrium risk-free interest rate, the equilibrium Girsanov kernel, and the equilibrium stochastic discount factor. See Appendix A for the necessary background in arbitrage theory.

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Notes

  1. 1.

    The representative agent’s financial wealth consists of a market portfolio of traded assets. The assumption that r t = r(t, X t) then means that the economy’s risk-free rate depends on the total wealth state variable X.

  2. 2.

    See Appendix A for the definition of this object.

References

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Björk, T., Khapko, M., Murgoci, A. (2021). A Simple Equilibrium Model. In: Time-Inconsistent Control Theory with Finance Applications. Springer Finance. Springer, Cham. https://doi.org/10.1007/978-3-030-81843-2_14

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