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Does Market Incompleteness Matter?

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Author Info
David K. Levine () (University of California at Los Angeles)
William R. Zame () (University of California at Los Angeles, Los Angeles)

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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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Publisher 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. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June. [Downloadable!] (restricted)
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  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. [Downloadable!]
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  3. Bewley, Truman, 1977. "The permanent income hypothesis: A theoretical formulation," Journal of Economic Theory, Elsevier, vol. 16(2), pages 252-292, December. [Downloadable!] (restricted)
  4. 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. [Downloadable!] (restricted)
  5. Felix Kubler & Karl Schmedders, 2000. "Incomplete Markets, Transitory Shocks and Welfare," Levine's Working Paper Archive 2133, David K. Levine. [Downloadable!]
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  6. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March. [Downloadable!] (restricted)
  7. Ross, Stephen A, 1976. "Options and Efficiency," The Quarterly Journal of Economics, MIT Press, vol. 90(1), pages 75-89, February. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
  9. 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. [Downloadable!] (restricted)
  10. Calvet, Laurent E., 2001. "Incomplete Markets and Volatility," Journal of Economic Theory, Elsevier, vol. 98(2), pages 295-338, June. [Downloadable!] (restricted)
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  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. [Downloadable!]
  12. Telmer, Chris I, 1993. " Asset-Pricing Puzzles and Incomplete Markets," Journal of Finance, American Finance Association, vol. 48(5), pages 1803-32, December. [Downloadable!] (restricted)
  13. Magill, Michael & Quinzii, Martine, 1994. "Infinite Horizon Incomplete Markets," Econometrica, Econometric Society, vol. 62(4), pages 853-80, July. [Downloadable!] (restricted)
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  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. [Downloadable!] (restricted)
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  15. Townsend, Robert M, 1994. "Risk and Insurance in Village India," Econometrica, Econometric Society, vol. 62(3), pages 539-91, May. [Downloadable!] (restricted)
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