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Information-Constrained Optima with Retrading: An Externality and Its Market-Based Solution

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  • Kilenthong, Weerachart
  • Townsend, Robert

Abstract

This paper studies the efficiency of competitive equilibria in environments with a moral hazard problem and unobserved states, both with retrading in ex post spot markets. The interaction between private information problems and the possibility of retrade creates an externality, unless preferences have special, restrictive properties. The externality is internalized by allowing agents to contract ex ante on market fundamentals determining the spot price or interest rate, over and above contracting on actions and outputs. Then competitive equilibria are equivalent with the appropriate notion of constrained Pareto optimality. Examples show that it is possible to have multiple market fundamentals or price islands, created endogenously in equilibrium.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 20725.

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Date of creation: 01 Feb 2010
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Handle: RePEc:pra:mprapa:20725

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Keywords: Externalities; Private information; Moral hazard; Retrading; Walrasian equilibrium; Constrained efficiency; Decentralization;

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  1. Marcos B. Lisboa, 2001. "Moral hazard and general equilibrium in large economies," Economic Theory, Springer, Springer, vol. 18(3), pages 555-575.
  2. Prescott, Edward C & Townsend, Robert M, 1984. "General Competitive Analysis in an Economy with Private Information," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 1-20, February.
  3. Alberto Bennardo & Pierre-Andre Chiappori, 2003. "Bertrand and Walras Equilibria Under Moral Hazard," Levine's Working Paper Archive, David K. Levine 618897000000000748, David K. Levine.
  4. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, Elsevier, vol. 48(3), pages 513-548, December.
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  6. Mikhail Golosov & Aleh Tsyvinski, 2005. "Optimal Taxation with Endogenous Insurance Markets," NBER Working Papers, National Bureau of Economic Research, Inc 11185, National Bureau of Economic Research, Inc.
  7. Guido Lorenzoni, 2007. "Inefficient Credit Booms," NBER Working Papers, National Bureau of Economic Research, Inc 13639, National Bureau of Economic Research, Inc.
  8. Edward C Prescott & Robert M Townsend, 2010. "Pareto Optima and Competitive Equilibria With Adverse Selection and Moral Hazard," Levine's Working Paper Archive, David K. Levine 2069, David K. Levine.
  9. Franklin Allen & Douglas Gale, 2003. "Financial Intermediaries and Markets," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 00-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
  10. Emmanuel Farhi & Mikhail Golosov & Aleh Tsyvinski, 2008. "A Theory of Liquidity and Regulation of Financial Intermediation," Levine's Working Paper Archive, David K. Levine 122247000000002006, David K. Levine.
  11. Ricardo Caballero & Arvind Krishnamurthy, 2001. "Smoothing Sudden Stops," NBER Working Papers, National Bureau of Economic Research, Inc 8427, National Bureau of Economic Research, Inc.
  12. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  13. Greenwald, Bruce C & Stiglitz, Joseph E, 1986. "Externalities in Economies with Imperfect Information and Incomplete Markets," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 101(2), pages 229-64, May.
  14. John C. Fellingham & Young K. Kwon & D. Paul Newman, 1984. "Ex ante Randomization in Agency Models," RAND Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 15(2), pages 290-301, Summer.
  15. J C Fellingham & Y K Kwon & D P Newman, 2010. "Ex Ante Randomization in Agency Models," Levine's Working Paper Archive, David K. Levine 1953, David K. Levine.
  16. Edward Simpson Prescott & Robert M. Townsend, 2006. "Firms as Clubs in Walrasian Markets with Private Information," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 114(4), pages 644-671, August.
  17. Bisin, A. & Geanakoplos, J.D. & Gottardi, P. & Minelli, E. & Polemarchakis, H., 2011. "Markets and contracts," Journal of Mathematical Economics, Elsevier, Elsevier, vol. 47(3), pages 279-288.
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Citations

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Cited by:
  1. Weerachart T. Kilenthong & Robert M. Townsend, 2014. "A Market Based Solution to Price Externalities: A Generalized Framework," NBER Working Papers, National Bureau of Economic Research, Inc 20275, National Bureau of Economic Research, Inc.
  2. Weerachart Kilenthong & Robert Townsend, 2014. "Segregated Security Exchanges with Ex Ante Rights to Trade: A Market-Based Solution to Collateral-Constrained Externalities," NBER Working Papers, National Bureau of Economic Research, Inc 20086, National Bureau of Economic Research, Inc.
  3. Corbae, Dean & Marimon, Ramon, 2011. "Introduction to Incompleteness and Uncertainty in Economics," Journal of Economic Theory, Elsevier, Elsevier, vol. 146(3), pages 775-784, May.

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