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Incomplete Markets, Transitory Shocks, and Welfare

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  • Felix Kubler

    (Stanford University)

  • Karl Schmedders

    (Northwestern University)

Abstract

Although equilibrium allocations in models with incomplete markets are generally not Pareto-efficient, it is often argued that quantitative welfare losses from missing assets are small when time horizons are long and shocks are transitory. In this paper, we use a computational analysis to show that even in the simplest infinite horizon model without aggregate uncertainty welfare losses can be substantial. Furthermore we show that in this model welfare losses from incomplete markets do not necessarily disappear when one considers calibrations of the model in which agent become very patient. We argue that when the economic model is calibrated to higher frequency data, the period persistence of negative income shocks must increase as well. In this case the welfare loss of incomplete markets remains constant even as agents' rate of time preference tends to one. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1006/redy.2001.0134
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 4 (2001)
Issue (Month): 4 (October)
Pages: 747-766

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Handle: RePEc:red:issued:v:4:y:2001:i:4:p:747-766

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Keywords: incomplete markets; heterogeneous agents; welfare loss; persistent shocks.;

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