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Does Market Incompleteness Matter?

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  • David K. Levine

    () (University of California at Los Angeles)

  • William R. Zame

    () (University of California at Los Angeles, Los Angeles)

Abstract

This paper argues that incompleteness of intertemporal financial markets has little effect (on welfare, prices, or consumption) in an economy with a single consumption good, provided that traders are long-lived and patient, a riskless bond is traded, shocks are transitory, and there is no aggregate risk. In an economy with aggregate risk, a similar conclusion holds, provided traders share the same CRRA utility function and the right assets are traded. Examples demonstrate that these conclusions need not hold if the wrong assets are traded or if the economy has multiple consumption goods. Copyright The Econometric Society 2002.

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Bibliographic Info

Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 70 (2002)
Issue (Month): 5 (September)
Pages: 1805-1839

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Handle: RePEc:ecm:emetrp:v:70:y:2002:i:5:p:1805-1839

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  1. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  2. David K. Levine & William Zame, 1996. "Debt Constraints and Equilibrium in Infinite Horizon Economies with Incomplete Markets," Levine's Working Paper Archive 1954, David K. Levine.
  3. Robert M. Townsend, . "Risk and Insurance in Village India," University of Chicago - Population Research Center 91-3a, Chicago - Population Research Center.
  4. Felix Kubler & Karl Schmedders, 2000. "Incomplete Markets, Transitory Shocks and Welfare," Levine's Working Paper Archive 2133, David K. Levine.
  5. Atsushi Kajii & Chiaki Hara, 2003. "On the Range of the Risk-Free Interest Rate in Incomplete Markets," Levine's Bibliography 666156000000000383, UCLA Department of Economics.
  6. Laurent E. Calvet, 1999. "Incomplete Markets and Volatility," Harvard Institute of Economic Research Working Papers 1865, Harvard - Institute of Economic Research.
  7. Ross, Stephen A, 1976. "Options and Efficiency," The Quarterly Journal of Economics, MIT Press, vol. 90(1), pages 75-89, February.
  8. Lucas, Deborah J., 1994. "Asset pricing with undiversifiable income risk and short sales constraints: Deepening the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 325-341, December.
  9. Chris I. Telmer, 1991. "Asset Pricing Puzzles and Incomplete Markets," Working Papers 806, Queen's University, Department of Economics.
  10. Kreps, David M., 1981. "Arbitrage and equilibrium in economies with infinitely many commodities," Journal of Mathematical Economics, Elsevier, vol. 8(1), pages 15-35, March.
  11. Chiaki Hara, 2000. "Bounds on the Risk-Free Interest Rate in Incomplete Markets With and Without Utility Functions Exhibiting Constant Absolute Risk Aversion," Econometric Society World Congress 2000 Contributed Papers 1448, Econometric Society.
  12. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
  13. Magill, M. & Quinzii, M., 1993. "Infinite Horizon Incomplete Markets," Papers 9320, Southern California - Department of Economics.
  14. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March.
  15. Bewley, Truman, 1977. "The permanent income hypothesis: A theoretical formulation," Journal of Economic Theory, Elsevier, vol. 16(2), pages 252-292, December.
  16. Yaari, Menahem E., 1976. "A law of large numbers in the theory of consumer's choice under uncertainty," Journal of Economic Theory, Elsevier, vol. 12(2), pages 202-217, April.
  17. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, April.
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