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Endogenous market incompleteness with investment risks

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  • Meh, Cesaire A.
  • Quadrini, Vincenzo

Abstract

This Paper studies a general equilibrium economy in which agents have the ability to invest in a risky technology. The investment risk cannot be fully insured with optimal contracts because shocks are private information. We show that the presence of investment risks leads to under-accumulation of capital relative to an economy where idiosyncratic shocks can be fully insured. We also show that the availability of state-contingent (optimal) contracts – compared to simple debt contracts – brings the aggregate stock of capital close to the complete markets level. Institutional reforms that make possible the use of these contracts have important welfare consequences.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 30 (2006)
Issue (Month): 11 (November)
Pages: 2143-2165

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Handle: RePEc:eee:dyncon:v:30:y:2006:i:11:p:2143-2165

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  1. Quadrini, Vincenzo, 1999. "The Importance of Entrepreneurship for Wealth Concentration and Mobility," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 45(1), pages 1-19, March.
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  5. Huggett, Mark, 1996. "Wealth distribution in life-cycle economies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 38(3), pages 469-494, December.
  6. Mikkelson, Wayne H. & Partch, M. Megan & Shah, Kshitij, 1997. "Ownership and operating performance of companies that go public," Journal of Financial Economics, Elsevier, Elsevier, vol. 44(3), pages 281-307, June.
  7. Vincenzo Quadrini, 1997. "Entrepreneurship, saving and social mobility," Discussion Paper / Institute for Empirical Macroeconomics 116, Federal Reserve Bank of Minneapolis.
  8. Fudenberg, Drew & Holmstrom, Bengt & Milgrom, Paul, 1990. "Short-term contracts and long-term agency relationships," Journal of Economic Theory, Elsevier, vol. 51(1), pages 1-31, June.
  9. S. Rao Aiyagari, 1994. "Optimal capital income taxation with incomplete markets, borrowing constraints, and constant discounting," Working Papers 508, Federal Reserve Bank of Minneapolis.
  10. Hansen, Gary D & Imrohoroglu, Ayse, 1992. "The Role of Unemployment Insurance in an Economy with Liquidity Constraints and Moral Hazard," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(1), pages 118-42, February.
  11. Erik Hurst & Annamaria Lusardi, 2004. "Liquidity Constraints, Household Wealth, and Entrepreneurship," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 112(2), pages 319-347, April.
  12. Josep Pijoan-Mas, 2003. "Precautionary Savings Or Working Longer Hours?," Working Papers, CEMFI wp2003_0311, CEMFI.
  13. Chatterjee, Satyajit, 1994. "Transitional dynamics and the distribution of wealth in a neoclassical growth model," Journal of Public Economics, Elsevier, vol. 54(1), pages 97-119, May.
  14. William M. Gentry & R. Glenn Hubbard, 2000. "Entrepreneurship and Household Saving," NBER Working Papers 7894, National Bureau of Economic Research, Inc.
  15. Levine, Ross, 1996. "Financial development and economic growth : views and agenda," Policy Research Working Paper Series 1678, The World Bank.
  16. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  17. Rios-Rull, Jose-Victor, 1994. "On the quantitative importance of market completeness," Journal of Monetary Economics, Elsevier, Elsevier, vol. 34(3), pages 463-496, December.
  18. Veronika Dolar & Césaire Meh, 2002. "Financial Structure and Economic Growth: A Non-Technical Survey," Working Papers 02-24, Bank of Canada.
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Citations

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Cited by:
  1. Mele, Antonio, 2014. "Repeated moral hazard and recursive Lagrangeans," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 42(C), pages 69-85.
  2. Carlson Mark A & King Thomas & Lewis Kurt, 2011. "Distress in the Financial Sector and Economic Activity," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 11(1), pages 1-31, June.
  3. Panousi, Vasia, 2009. "Financial Integration and Capital Accumulation," MPRA Paper 24238, University Library of Munich, Germany.
  4. Francisco Covas, 2005. "Uninsured Idiosyncratic Production Risk with Borrowing Constraints," Working Papers 05-26, Bank of Canada.
  5. Damiano Sandri, 2010. "Growth and Capital Flows with Risky Entrepreneurship," IMF Working Papers 10/37, International Monetary Fund.
  6. Michelacci, Claudio & Schivardi, Fabiano, 2008. "Does Idiosyncratic Business Risk Matter?," CEPR Discussion Papers 6910, C.E.P.R. Discussion Papers.
  7. Andrea Caggese, 2006. "Entrepreneurial Risk, Investment and Innovation," 2006 Meeting Papers, Society for Economic Dynamics 412, Society for Economic Dynamics.
  8. Dunbar, Geoffrey, 2013. "Returns-to-scale and the equity premium puzzle," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(9), pages 1736-1754.
  9. Francisco Covas & Shigeru Fujita, 2007. "Private risk premium and aggregate uncertainty in the model of uninsurable investment risk," Working Papers 07-30, Federal Reserve Bank of Philadelphia.
  10. Stefan Niemann & Michael Evers & Marc Schiffbauer, 2007. "Inflation, Investment Composition and Total Factor Productivity," Economics Discussion Papers, University of Essex, Department of Economics 632, University of Essex, Department of Economics.
  11. Angeletos, George-Marios & Panousi, Vasia, 2009. "Revisiting the supply side effects of government spending," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(2), pages 137-153, March.

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