Endogenous Market Incompleteness Without Market Frictions: Dynamic Suboptimality of Competitive Equilibrium in Multiperiod Overlapping Generations Economies
AbstractIn this paper, we show that within the set of stochastic three-period-lived OLG economies with productive assets (such as land), markets are necessarily sequentially incomplete, and agents in the model do not share risk optimally. We start by characterizing perfect risk sharing and find that it requires a state-dependent consumption claims which depend only on the exogenous shock realizations. We show then that the recursive competitive equilibrium of any overlapping generations economy with weakly more than three generations is not strongly stationary. This then allows us to show directly that there are short-run Pareto improvements possible in terms of risk-sharing and hence, that the recursive competitive equilibrium is not Pareto optimal. We then show that a financial reform which eliminates the equity asset and replaces it with zero net supply insurance contracts (Arrow securities) will implement to Pareto optimal stochastic steady-state known to exist in the model. Finally, we also show via numerical simulations that a system of government taxes and transfers can lead to a Pareto improvement over the competitive equilibrium in the model.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Carnegie Mellon University, Tepper School of Business in its series GSIA Working Papers with number 2005-E37.
Date of creation:
Date of revision:
Contact details of provider:
Postal: Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213-3890
Web page: http://www.tepper.cmu.edu/
Other versions of this item:
- Henriksen, Espen & Spear, Stephen, 2012. "Endogenous market incompleteness without market frictions: Dynamic suboptimality of competitive equilibrium in multiperiod overlapping generations economies," Journal of Economic Theory, Elsevier, vol. 147(2), pages 426-449.
- D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
- D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-05-14 (All new papers)
- NEP-DGE-2005-05-14 (Dynamic General Equilibrium)
- NEP-MAC-2005-05-14 (Macroeconomics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Felix Kubler & Karl Schmedders, 2005. "Approximate versus Exact Equilibria in Dynamic Economies," Econometrica, Econometric Society, vol. 73(4), pages 1205-1235, 07.
- Dirk Krueger & Felix Kubler, 2002. "Intergenerational Risk-Sharing via Social Security when Financial Markets Are Incomplete," American Economic Review, American Economic Association, vol. 92(2), pages 407-410, May.
- Spear, Stephen E. & Srivastava, Sanjay, 1986. "Markov rational expectations equilibria in an overlapping generations model," Journal of Economic Theory, Elsevier, vol. 38(1), pages 35-62, February.
- Wang, Ping, 1993.
"Money, competitive efficiency, and intergenerational transactions,"
Journal of Monetary Economics,
Elsevier, vol. 32(2), pages 303-320, November.
- Wang, P., 1991. "Money, Competitive Efficiency and Intergenerational Transactions," Papers 10-91-6, Pennsylvania State - Department of Economics.
- Peled, Dan, 1982. "Informational diversity over time and the optimality of monetary equilibria," Journal of Economic Theory, Elsevier, vol. 28(2), pages 255-274, December.
- Kehoe, Timothy J. & Levine, David K., 1990.
"The economics of indeterminacy in overlapping generations models,"
Journal of Public Economics,
Elsevier, vol. 42(2), pages 219-243, July.
- Timothy J. Kehoe & David K. Levine, 1990. "The Economics of Indeterminacy in Overlapping Generations Models," Levine's Working Paper Archive 2193, David K. Levine.
- Rao Aiyagari, S. & Peled, Dan, 1991. "Dominant root characterization of Pareto optimality and the existence of optimal equilibria in stochastic overlapping generations models," Journal of Economic Theory, Elsevier, vol. 54(1), pages 69-83, June.
- Zilcha, Itzhak, 1990. "Dynamic efficiency in overlapping generations models with stochastic production," Journal of Economic Theory, Elsevier, vol. 52(2), pages 364-379, December.
- Duffie, Darrell, et al, 1994. "Stationary Markov Equilibria," Econometrica, Econometric Society, vol. 62(4), pages 745-81, July.
- Chattopadhyay, Subir & Gottardi, Piero, 1999.
"Stochastic OLG Models, Market Structure, and Optimality,"
Journal of Economic Theory,
Elsevier, vol. 89(1), pages 21-67, November.
- Piero Gottardi & Subir Chattopadhyay, 1999. "- Stochastic Olg Models, Market Structure And Optimality," Working Papers. Serie AD 1999-15, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
- Subir Chattopadhyay & Piero Gottardi, 1999. "Stochastic OLG Models, Market Structure, and Optimality," Working Papers 99-12, Brown University, Department of Economics.
- Andrew Abel & Gregory N. Mankiw & Lawrence H. Summers & Richard Zeckhauser, .
"Assessing Dynamic Efficiency: Theory and Evidence,"
Rodney L. White Center for Financial Research Working Papers
14-88, Wharton School Rodney L. White Center for Financial Research.
- Muench, Thomas J., 1977. "Optimality, the interaction of spot and futures markets, and the nonneutrality of money in the lucas model," Journal of Economic Theory, Elsevier, vol. 15(2), pages 325-344, August.
- Demange, G., 2000.
"On Optimality of Intergenerational Risk Sharing,"
DELTA Working Papers
2000-05, DELTA (Ecole normale supérieure).
- Alessandro Citanna & Paolo Siconolfi, 2010. "Recursive Equilibrium in Stochastic Overlapping-Generations Economies," Econometrica, Econometric Society, vol. 78(1), pages 309-347, 01.
- Spear, Stephen E., 1985. "Rational expectations in the overlapping generations model," Journal of Economic Theory, Elsevier, vol. 35(2), pages 251-275, August.
- Gale, David, 1973. "Pure exchange equilibrium of dynamic economic models," Journal of Economic Theory, Elsevier, vol. 6(1), pages 12-36, February.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Steve Spear).
If references are entirely missing, you can add them using this form.