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Multiplicity in General Financial Equilibrium with Portfolio Constraints, Second Version

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  • Suleyman Basak

    ()
    (London Business School and CEPR, Institute of Finance and Accounting)

  • David Cass

    ()
    (Department of Economics, University of Pennsylvania)

  • Juan Manuel Licari

    ()
    (Department of Economics, University of Pennsylvania)

  • Anna Pavlova

    ()
    (London Business School and CEPR, Institute of Finance and Accounting)

Abstract

This paper explores the role of portfolio constraints in generating multiplicity of equilibrium. We present a simple financial market economy with two goods and two households, households who face constraints on their ability to take unbounded positions in risky stocks. Absent such constraints, equilibrium allocation is unique and is Pareto efficient. With one portfolio constraint in place, the efficient equilibrium is still possible; however, additional inefficient equilibria in which the constraint is binding may emerge. We show further that with portfolio constraints cum incomplete markets, there may be a continuum of equilibria; adding incomplete markets may lead to real indeterminacy.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 06-020.

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Length: 36 pages
Date of creation: 01 Mar 2006
Date of revision: 17 Jul 2006
Handle: RePEc:pen:papers:06-020

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Keywords: Multiple equilibria; asset pricing; portfolio constraints; indeterminacy; financial equilibrium;

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  1. Peter M. Demarzo & Ron Kaniel & Ilan Kremer, 2004. "Diversification as a Public Good: Community Effects in Portfolio Choice," Journal of Finance, American Finance Association, American Finance Association, vol. 59(4), pages 1677-1716, 08.
  2. Detemple, Jerome & Murthy, Shashidhar, 1997. "Equilibrium Asset Prices and No-Arbitrage with Portfolio Constraints," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 10(4), pages 1133-74.
  3. Basak, Suleyman & Cuoco, Domenico, 1998. "An Equilibrium Model with Restricted Stock Market Participation," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 11(2), pages 309-41.
  4. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, American Economic Association, vol. 80(5), pages 999-1021, December.
  5. Cass, David & Siconolfi, Paolo & Villanacci, Antonio, 2001. "Generic regularity of competitive equilibria with restricted participation," Journal of Mathematical Economics, Elsevier, vol. 36(1), pages 61-76, September.
  6. Pavlova, Anna & Rigobon, Roberto, 2005. "Wealth Transfers, Contagion and Portfolio Constraints," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5117, C.E.P.R. Discussion Papers.
  7. Geanakoplos, J. & Magill, M. & Quinzii, M. & Dreze, J., . "Generic inefficiency of stock market equilibrium when markets are incomplete," CORE Discussion Papers RP, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) -916, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  8. Jérôme B. Detemple & Shashidhar Murthy, 1997. "Equilibrium Asset Prices and No-Arbitrage with Portfolio Constraints," CIRANO Working Papers, CIRANO 97s-12, CIRANO.
  9. Jérôme Detemple & Angel Serrat, 2003. "Dynamic Equilibrium with Liquidity Constraints," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 16(2), pages 597-629.
  10. Cass, David & Pavlova, Anna, 2003. "On Trees And Logs," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 4233-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  11. Gadi Barlevy & Pietro Veronesi, 2000. "Rational Panics and Stock Market Crashes," CRSP working papers, Center for Research in Security Prices, Graduate School of Business, University of Chicago 483, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  12. Duffie, Darrell & Shafer, Wayne, 1985. "Equilibrium in incomplete markets: I : A basic model of generic existence," Journal of Mathematical Economics, Elsevier, vol. 14(3), pages 285-300, June.
  13. Harrison Hong & Jeremy C. Stein, 2003. "Differences of Opinion, Short-Sales Constraints, and Market Crashes," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 16(2), pages 487-525.
  14. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, Econometric Society, vol. 46(6), pages 1429-45, November.
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