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To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jfineco.2005.07.013 Byline: Alan Kraus (a), Jacob S. Sagi (b) Abstract: We investigate an economy of heterogeneous agents that cannot specify all exogenous welfare-relevant events and consequently view the impact of unforeseen contingencies as utility shocks. In this setting we characterize an appropriate market equilibrium concept when securities can trade only on demand- and price-contingent events. We establish the existence of an equilibrium for a class of parametric models in which aggregating taste shocks across agents can lead to nonconsumption pricing factors. To fit the stylized facts, (i) non consumption factors must dominate the pricing kernel and contribute to the variation of the wealth-consumption ratio, (ii) markets must be incomplete and the set of claims that are traded endogenously determined, (iii) agents' preferences with respect to unforeseen contingencies must be non-expected utility, and, (iv) although non-consumption pricing factors can be conditionally uncorrelated with aggregate consumption shocks, they must be correlated with shocks to expected consumption growth. Author Affiliation: (a) University of British Columbia, Vancouver, BC, Canada V6T 1Z2 (b) Haas School of Business, University of California at Berkeley, Berkeley, CA, 94720, USA Article History: Received 2 July 2004; Revised 9 May 2005; Accepted 21 July 2005 Article Note: (footnote) [star] We are grateful to Jonathan Berk, Murray Carlson, Pierre Colin-Dufresne, Greg Duffee, Ilan Kremer, Martin Lettau, Rajnish Mehra and an anonymous referee for helpful comments and suggestions. Alan Kraus gratefully acknowledges support from SSHRC.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jmateco.2006.04.010 Byline: Alan Kraus (a), Jacob S. Sagi (b) Keywords: Inter-temporal choice; Flexibility; Non-expected utility; Decision theory; Incomplete preference relations; Utility representation; Time consistency; Unforeseen contingencies Abstract: We derive an inter-temporal theory of choice, in the spirit of Kreps and Porteus [Kreps, D.M., Porteus, E.L., 1978. Temporal resolution of uncertainty and dynamic choice theory. Econometrica 46, 185-200], where decision makers have incomplete preferences. This can be used to model indecisiveness as well as unforeseen contingencies. The key to our approach is a time consistency condition and therefore the normative connection between ex-ante and ex-post choice. The time consistency condition enables a representation that is a straight forward extension of recursive utility with the exception that it features an inter-temporal 'utility for flexibility'. Author Affiliation: (a) Faculty of Commerce, University of British Columbia, 2053 Main Mall, Vancouver, BC, Canada V6T 1Z2 (b) Haas School of Business, University of California at Berkeley, 545 Student Services Building, Berkeley, CA 94720-1900, United States Article History: Received 16 November 2004; Revised 29 December 2005; Accepted 1 April 2006

A paper that presents us with a paradox has a natural appeal. The paradox in Grossman's paper--that "when a market is a perfect aggregator of information it removes private incentives to collect information" is certainly not trivial from the viewpoint of anyone concerned with the functioning of securities markets. A broader viewpoint is also possible, moreoever, since I find Grossman's problem closely related to an older question in price theory: When every market participant is convinced that the efforts of arbitrageurs ensure that the same good never (for any instant) is offered at different prices at the same time, how can the arbitrage operation that ensures this condition survive? Most price theory texts do not address this problem directly, or at all, although I think they should, and Grossman deserves credit for ably illuminating its counterpart in the theory of efficient securities markets. [ABSTRACT FROM AUTHOR]

New factor analysis tests developed for the arbitrage pricing theory (APT) emphasize the number of securities involved in the two stages of the APT, the number of factors that affect the pricing of the securities during both stages, and the stationarity of the APT (the model's explanation of returns realized, based on prior-period risks). The tests developed indicate that: (1) unique risk is as important in arbitrage pricing situations as is common risk, and (2) as the number of securities studied is increased, so does the number of factors affecting arbitrage pricing, which is inconsistent with the original APT. A discussion of the research presented argues that the tests developed do not refute the APT, but are useful when studying the stochastic behavior of securities' returns.