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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
4807.
Find related papers by JEL classification: D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information E20 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
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