June 16, 2014
Application of Radner Equilibrium Theory to Financial Planning
Bhavin Shah
Director
Radner Equilibrium (1968) is a model of financial markets. Radner Equilibrium is a theory concerning economic decision making. According to this theory, if economic decision makers had access to unlimited computational capacity, they would be able to make an optimal allocation of resources based on economic equilibrium even in the face of uncertainty. Radner Equilibrium was introduced by American economist Roy Radner in 1968, and explores the condition of competitive equilibrium under uncertainty.
This exploration of competitive equilibrium under uncertainty has indicated that if economic decision makers are uncertain about the environment, and if they have information about the environment, optimum allocation of resources can be achieved, relative to the given structure of information.
An equilibrium is a price system together with acts of consumers and producers such that, for the given price system,
- Each consumer maximizes his preferences subject to his wealth constraint,
- Each producer maximizes his profits, and
- Total demand equals total supply
Similarly, financial planning refers to optimum utilization & proper asset allocation of the funds available. Financial planning helps in estimating present & future requirements of clients based on the information compiled from clients & understanding their goals.
Financial Planning helps attain Equilibrium under Uncertainty
Uncertainty can present challenges and opportunities. Financial planning helps in arriving at decisions which maintains the balance between challenges and opportunities. One may find extremely unsettled by the ups and downs & uncertainties of the market. It has become increasingly difficult to make on what you should do with your money. From the television, to next-door neighbors to Internet chat rooms, everyone seems to have an opinion, but how can you be sure you are getting the right advice? What can you do to ensure you make the right choices? A thought out financial plan may be the answer.
A financial plan can help you negotiate the twists and turns of the economic environment because your investment strategy is based on your own situation and goals.
Insurance Planning helps Manage financial Risk in Uncertainty
Risk associated with financial planning can become the reason of not meeting the target of clients. Insurance Planning involves the pooling of individual risks. Decision on the most appropriate policy suggested by financial advisor should be proportionate to the risk posed by the client.
Equilibrium of Plans & Expectations
Planning under uncertainty is a common class of problems. This equilibrium can be achieved only by balancing individual plan and course of actions. Equilibrium for financial advisor can be achieved if plans drawn are consistent and in line with individual goals. Just as the economist would fail in his duty to provide a satisfactory theory if he did not recognize and take account things like “prices & demand”, a financial advisor would also fail if he does not account for individuals expectation subject to his clients wealth constraints.
Thus, from equilibrium model we can observe that financial advisors can make plans based on optimal condition of the future expectations of the client and should be consistent with course of action.
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