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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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References

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  12. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Wiley Blackwell, vol. 70(3), pages 569-587, 07.
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Citations

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Cited by:
  1. Covas, Francisco, 2006. "Uninsured idiosyncratic production risk with borrowing constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2167-2190, November.
  2. Mele, Antonio, 2011. "Repeated moral hazard and recursive Lagrangeans," MPRA Paper 30310, University Library of Munich, Germany.
  3. Caggese, Andrea, 2012. "Entrepreneurial risk, investment, and innovation," Journal of Financial Economics, Elsevier, vol. 106(2), pages 287-307.
  4. Stefan Niemann & Michael Evers & Marc Schiffbauer, 2007. "Inflation, Investment Composition and Total Factor Productivity," Economics Discussion Papers 632, University of Essex, Department of Economics.
  5. 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.
  6. claudio Michelacci & Fabiano Schivardi, 2008. "Does Idiosyncratic Business Risk Matter?," EIEF Working Papers Series 0813, Einaudi Institute for Economics and Finance (EIEF), revised Jul 2008.
  7. Panousi, Vasia, 2009. "Financial Integration and Capital Accumulation," MPRA Paper 24238, University Library of Munich, Germany.
  8. Dunbar, Geoffrey, 2013. "Returns-to-scale and the equity premium puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 37(9), pages 1736-1754.
  9. 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.
  10. Angeletos, George-Marios & Panousi, Vasia, 2009. "Revisiting the supply side effects of government spending," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 137-153, March.
  11. Damiano Sandri, 2014. "Growth and Capital Flows with Risky Entrepreneurship," American Economic Journal: Macroeconomics, American Economic Association, vol. 6(3), pages 102-23, July.

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