Pareto improving financial innovation in incomplete markets
AbstractIn this paper we develop a differential technique for investigating the welfare effects of financial innovation in incomplete markets. Utilizing this technique, and after parametrizing the standard competitive, pure-exchange economy by both endowments and utility functions, we establish the following (weakly) generic property: Let S be the number of states, I be the number of assets and H be the number of households, and consider a particular financial equilibrium. Then, provided that the degree of market incompleteness is sufficiently larger than the extent of household heterogeneity, S-I\geq2H-1 [resp. S-I\geqH+1], there is an open set of single assets [resp. pairs of assets] whose introduction can make every household better off (and, symmetrically, an open set of single assets [resp. pairs of assets] whose introduction can make them all worse off ). We also devise a very simple nonparametric procedure for reducing extensive household heterogeneity to manageable size, a procedure which not only makes our restrictions on market incompleteness more palatable, but could also prove to be quite useful in other applications involving smooth analysis.
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Bibliographic InfoArticle provided by Springer in its journal Economic Theory.
Volume (Year): 11 (1998)
Issue (Month): 3 ()
Note: Received: August 14, 1995; revised version: April 14, 1997
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Web page: http://link.springer.de/link/service/journals/00199/index.htm
Find related papers by JEL classification:
- C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
- D60 - Microeconomics - - Welfare Economics - - - General
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
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