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Dynamic Competitive Economies with Complete Markets and Collateral Constraints

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  • GOTTARDI, Piero
  • KUBLER, Felix

Abstract

In this paper we examine the competitive equilibria of a dynamic stochastic economy with complete markets and collateral constraints. We show that, provided both the set of asset payoffs and collateral levels are sufficiently rich, the equilibrium allocations with sequential trades and collateral constraints are equivalent to those obtained in Arrow-Debreu markets subject to a series of appropriate limited pledgeability constraints. We provide sufficient conditions for equilibria to be Pareto efficient and show that when collateral is scarce equilibria are also often constrained inefficient, in the sense that imposing tighter borrowing restrictions can make everybody in the economy better off. We derive sufficient conditions for the existence of Markov equilibria and show that they typically have finite support when there are two agents' types. The model is then tractable and its equilibria can be computed with arbitrary accuracy. We carry outon this basis a quantitative assessment of the risk sharing and efficiency properties ofequilibria.

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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2012/17.

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Date of creation: 2012
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Handle: RePEc:eui:euiwps:eco2012/17

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  1. Felix Kubler & Karl Schmedders, 2001. "Stationary Equilibria in Asset-Pricing Models with Incomplete Markets and Collateral," Discussion Papers 1319, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Yili Chien & Harold Cole & Hanno Lustig, 2011. "A Multiplier Approach to Understanding the Macro Implications of Household Finance," Review of Economic Studies, Oxford University Press, vol. 78(1), pages 199-234.
  3. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  4. 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.
  5. S. Rao Aiyagari & Mark Gertler, 1998. ""Overreaction" of Asset Prices in General Equilibrium," NBER Working Papers 6747, National Bureau of Economic Research, Inc.
  6. Domenico Cuoco & Hua He, 2001. "Dynamic Aggregation and Computation of Equilibria in Finite-Dimensional Economies with Incomplete Financial Markets," Annals of Economics and Finance, Society for AEF, vol. 2(2), pages 265-296, November.
  7. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
  8. Timothy J. Kehoe & David K. Levine, 2000. "Liquidity Constrained vs. Debt Constrained Markets," Levine's Working Paper Archive 14, David K. Levine.
  9. Hanno Lustig, 2004. "The Market Price of Aggregate Risk and the Wealth Distribution," UCLA Economics Online Papers 299, UCLA Department of Economics.
  10. repec:fth:starer:98-25 is not listed on IDEAS
  11. Felix Kubler & Karl Schmedders, 2001. "Incomplete Markets, Transitory Shocks, and Welfare," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 747-766, October.
  12. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2009. "Quantitative macroeconomics with heterogeneous households," Staff Report 420, Federal Reserve Bank of Minneapolis.
  13. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  14. Kubler, Felix & Schmedders, Karl, 2002. "Recursive Equilibria In Economies With Incomplete Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 6(02), pages 284-306, April.
  15. Dana, Rose Anne, 1993. "Existence and Uniqueness of Equilibria When Preferences Are Additively Separable," Econometrica, Econometric Society, vol. 61(4), pages 953-57, July.
  16. Bewley, Truman, 1977. "The permanent income hypothesis: A theoretical formulation," Journal of Economic Theory, Elsevier, vol. 16(2), pages 252-292, December.
  17. repec:fth:starer:9825 is not listed on IDEAS
  18. Dan Cao, 2011. "Collateral Shortages, Asset Price and Investment Volatility with Heterogeneous Beliefs," Working Papers gueconwpa~11-11-01, Georgetown University, Department of Economics.
  19. Kilenthong, Weerachart & Townsend, Robert, 2007. "Market Based, Segregated Exchanges with Default Risk," MPRA Paper 20724, University Library of Munich, Germany, revised 12 Nov 2009.
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