Market uncertainty and market instability

While known factors are already reflected in efficient market prices, the main sources of market instability are unknown factors. These unknown factors shall not be referred to as market risk, but as market uncertainty. Efficient market prices can be considered as correct only in reference to a set of known factors. Therefore, from the perspective of market stability, the most important aspect is not market risk, but the degree of market uncertainty embedded in different assets or business models. The market uncertainty theory presented in this paper interprets market behaviour and market instability in a framework that takes into account both market risks and market uncertainty. The first half of the paper describes the market uncertainty theory comprising the market uncertainty theorem and the notion of heterogeneity of market uncertainty. The second half of the paper focuses on policy recommendations relevant for rating agencies, financial institutions, and public authorities.