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Endogenous Market Incompleteness with Investment Risks

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  • Meh, Césaire 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

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4807.

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Date of creation: Dec 2004
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Handle: RePEc:cpr:ceprdp:4807

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Keywords: Aggregate Capital; Asymmetric Information; optimal contracts;

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References

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  1. 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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  7. Quadrini, Vincenzo, 1999. "The Importance of Entrepreneurship for Wealth Concentration and Mobility," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 45(1), pages 1-19, March.
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  13. S. Rao Aiyagari, 1994. "Optimal capital income taxation with incomplete markets, borrowing constraints, and constant discounting," Working Papers 508, Federal Reserve Bank of Minneapolis.
  14. Veronika Dolar & Césaire Meh, 2002. "Financial Structure and Economic Growth: A Non-Technical Survey," Working Papers 02-24, Bank of Canada.
  15. William M. Gentry & R. Glenn Hubbard, 2000. "Entrepreneurship and Household Saving," NBER Working Papers 7894, National Bureau of Economic Research, Inc.
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  17. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.
  18. Huggett, Mark, 1996. "Wealth distribution in life-cycle economies," Journal of Monetary Economics, Elsevier, vol. 38(3), pages 469-494, December.
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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. 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.
  3. Mele, Antonio, 2011. "Repeated moral hazard and recursive Lagrangeans," MPRA Paper 30310, University Library of Munich, Germany.
  4. 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.
  5. Mark A. Carlson & Thomas B. King & Kurt F. Lewis, 2008. "Distress in the financial sector and economic activity," Finance and Economics Discussion Series 2008-43, Board of Governors of the Federal Reserve System (U.S.).
  6. Andrea Caggese, 2006. "Entrepreneurial risk, investment and innovation," Economics Working Papers 1011, Department of Economics and Business, Universitat Pompeu Fabra.
  7. Dunbar, Geoffrey, 2013. "Returns-to-scale and the equity premium puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 37(9), pages 1736-1754.
  8. 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.
  9. Panousi, Vasia, 2009. "Financial Integration and Capital Accumulation," MPRA Paper 24238, University Library of Munich, Germany.
  10. Stefan Niemann & Michael Evers & Marc Schiffbauer, 2007. "Inflation, Investment Composition and Total Factor Productivity," Economics Discussion Papers 632, University of Essex, Department of Economics.

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