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Arbitrage, Short Sales, and Financial Innovation

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Author Info
Allen, Franklin
Gale, Douglas

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Abstract

The authors describe a model of general equilibrium with incomplete markets in which firms can innovate by issuing arbitrary, costly securities. When short sales are prohibited, firms behave competitively and equilibrium is efficient. When short sales are allowed, these classical properties may fail. If unlimited short sales are allowed, imperfect competition may persist even when the number of potential innovators is large. If limited short sales are allowed, perfect competition may obtain in the limit, but equilibrium can be inefficient because of the presence of an externality: the private benefits of innovation for firms differ from the social benefits. Copyright 1991 by The Econometric Society.

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Publisher Info
Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 59 (1991)
Issue (Month): 4 (July)
Pages: 1041-68
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Handle: RePEc:ecm:emetrp:v:59:y:1991:i:4:p:1041-68

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  1. Sheridan Titman, 2001. "The Modigliani and Miller Theorem and Market Efficiency," NBER Working Papers 8641, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Acharya, Viral V & Bisin, Alberto, 2002. "Entrepreneurial Incentives in Stock Market Economies," CEPR Discussion Papers 3474, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  3. Maciej Firla-Cuchra & Tim Jenkinson, 2005. "Security Design in the Real World: Why are Securitization Issues Tranched?," Economics Series Working Papers 225, University of Oxford, Department of Economics. [Downloadable!]
  4. Louis Gagnon & Jonathan Witmer, 2009. "Short Changed? The Market's Reaction to the Short Sale Ban of 2008," Working Papers 09-23, Bank of Canada. [Downloadable!]
  5. Pradeep Dubey & John Geanakoplos & Martin Shubik, 2001. "Default and Punishment in General Equilibrium," Cowles Foundation Discussion Papers 1304, Cowles Foundation, Yale University. [Downloadable!]
    Other versions:
  6. T. Santos & J. Scheinkman, 2000. "Competition Among Exchanges," Princeton Economic Theory Papers 00s12, Economics Department, Princeton University.
    Other versions:
  7. Maciej Firla-Cuchra & Tim Jenkinson, 2005. "Why are Securitization Issues Tranched?," OFRC Working Papers Series 2005fe04, Oxford Financial Research Centre. [Downloadable!]
  8. Pradeep Dubey & John Geanakoplos & Martin Shubik, 2000. "Default in a General Equilibrium Model with Incomplete Markets," Cowles Foundation Discussion Papers 1247, Cowles Foundation, Yale University. [Downloadable!]
  9. Keith Sill, 1997. "The economic benefits and risks of derivative securities," Business Review, Federal Reserve Bank of Philadelphia, issue Jan, pages 15-26. [Downloadable!]
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