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Does Market Incompleteness Matter

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  • David K. Levine
  • William Zame

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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Bibliographic Info

Paper provided by David K. Levine in its series Levine's Working Paper Archive with number 78.

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Date of creation: 25 Sep 2001
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Handle: RePEc:cla:levarc:78

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References

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  1. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
  2. Atsushi Kajii & Chiaki Hara, 2003. "On the Range of the Risk-Free Interest Rate in Incomplete Markets," Levine's Bibliography 666156000000000383, UCLA Department of Economics.
  3. Levine, David K. & Zame, William R., 1996. "Debt constraints and equilibrium in infinite horizon economies with incomplete markets," Journal of Mathematical Economics, Elsevier, vol. 26(1), pages 103-131.
  4. 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.
  5. 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.
  6. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
  7. Townsend, Robert M, 1994. "Risk and Insurance in Village India," Econometrica, Econometric Society, vol. 62(3), pages 539-91, May.
  8. Bewley, Truman, 1977. "The permanent income hypothesis: A theoretical formulation," Journal of Economic Theory, Elsevier, vol. 16(2), pages 252-292, December.
  9. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  10. Felix Kubler & Karl Schmedders, 2000. "Incomplete Markets, Transitory Shocks and Welfare," Levine's Working Paper Archive 2133, David K. Levine.
  11. Magill, Michael & Quinzii, Martine, 1994. "Infinite Horizon Incomplete Markets," Econometrica, Econometric Society, vol. 62(4), pages 853-80, July.
  12. Duffie, J Darrell & Huang, Chi-fu, 1985. "Implementing Arrow-Debreu Equilibria by Continuous Trading of Few Long-lived Securities," Econometrica, Econometric Society, vol. 53(6), pages 1337-56, November.
  13. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, May.
  14. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
  15. Calvet, Laurent E., 2001. "Incomplete Markets and Volatility," Journal of Economic Theory, Elsevier, vol. 98(2), pages 295-338, June.
  16. Ross, Stephen A, 1976. "Options and Efficiency," The Quarterly Journal of Economics, MIT Press, vol. 90(1), pages 75-89, February.
  17. 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.
  18. Telmer, Chris I, 1993. " Asset-Pricing Puzzles and Incomplete Markets," Journal of Finance, American Finance Association, vol. 48(5), pages 1803-32, December.
  19. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  20. 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.
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