Knowledge that Transforms

The paper represents an application of the modern theory of competitive equilibrium to the case of uncertainty. Two theorems are presented: the first sets forth sufficient conditions for the existence of a competitive equilibrium for the case in which each economic agent has a given structure of information available and the second sets forth sufficient conditions for the existence of a competitive equilibrium for the case in which any available structure of information may be used. However, if the costs of obtaining information are included in the analysis, the conditions of the theorem may not be met. This is also true if the costs necessary to perform computations are included. In addition if part of the information available to economic agents concerns the behavior of other agents rather than concerning environmental variables, the conditions of the theorem may not be fulfilled. (Author)

This work is known to a generation of financial economists having marked the beginnings of the field known as financial econometrics. This edition sets out to show that the text, first written in 1964, is still relevant is still relevant at the beginning of the 21st century.

WE SHALL DEFINE a syndicate to be a of individual decision makers who must make a common decision under uncertainty, and who, as a result, will receive jointly a payoff to be shared among them. Our concern is to analyze the decision process of a syndicate when the members have diverse risk tolerances and/or diverse probability assessments of the uncertain events affecting the payoff. Of particular interest is the possiblity of constructing a surrogate group utility and a surrogate group probability assessment. Such constructions potentially have a role in the theory of finance; e.g., for determining the forms of organizational charters and financial instruments, as well as the modes of delegating the decision process to professional managers. The present treatment, however, is confined to tractable features embodying only a small measure of the complexity of practical situations. Of comparable importance are the ramifications for welfare theory; in particular, we shall be able to specify conditions under which Pareto optimal behavior by the satisfies the Savage axioms [15] foy consistent decision making under uncertainty, and to isolate the inconsistent characteristics in the contrary case. Arrow's original treatise [1] has been the source of most of the work on decision theory. Marschak [13], Radner [17], and Bower [6] have considered the case of a team, in which there is a joint utility function for the members. Harsanyi [9] and Theil [16] have considered the criterion that the decisions satisfy the Von Neumann-Morgenstern axioms, and others. Madansky [12] has imposed the external Bayes axiom in the case of a common utility function but differing probability assessments among the members. Christenson [7] has constructed an axiomatic system for the case of an investment banking syndicate that is a special case of the present study, except for certain institutional factors. Borch [3, 4, 5]

[1] Haavelmo, Trygve: Comment on Leontief, Wassily, Rates of Long-Run Economic Growth and Capital Transfer from Developed to Underdeveloped Areas, Study Week on The Econometric Approach to Development Planning (October 7-13, 1963), Pontificiae Academiae Scientiarvm Scripts Varia, (Amsterdam: North-Holland Publishing Company, 1965). [2] Chenery, Hollis and Alan M. Strout, Assistance and Economic Development, American Economic Review, 56, no. 4 (Sept. 1966), 679-733. [3] Rahman, Md. Anisur: Welfare Economics of Foreign Aid, Pakistan Development Review, Summer, 1967.