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Complete Markets, Enforcement Constraints and Intermediation

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  • Eva Carceles-Poveda
  • Arpad Abraham

Abstract

Alvarez and Jermann (2000) show that the constrained efficient allocations of endowment economies with complete markets and limited commitment can be decentralized with endogenous borrowing limits on the Arrow securities. In a model with capital accumulation, aggregate risk and competitive intermediaries, we show that such a decentralization is not possible unless one imposes an upper limit on the intermediaries' capital holdings. Since there is no empirical evidence of such restrictions, we also characterize the equilibrium with no capital accumulation constraints. We show that this allocation solves a similar system of equations to the one of the constrained optimal solution, a result which considerably simplifies the equilibrium computation. In addition, capital accumulation is higher in this case, since the intermediaries do not internalize that fact that a higher aggregate capital increases the incentives to default. Finally, this also implies that agents may enjoy a higher welfare in the long run in spite of the fact that this allocation is not constrained efficient

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2005 Meeting Papers with number 661.

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Date of creation: 2005
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Handle: RePEc:red:sed005:661

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Keywords: Production Economies; Enforcement Constraints; Financial Intermediation;

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  1. Albert Marcet & Ramon Marimon, 1994. "Recursive contracts," Economics Working Papers 337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.
  2. Patrick J. Kehoe & Fabrizio Perri, 2002. "Competitive equilibria with limited enforcement," Working Papers 621, Federal Reserve Bank of Minneapolis.
  3. Hanno Lustig & Yi-Li Chien, 2005. "The Market Price of Aggregate Risk and the Wealth Distribution," NBER Working Papers 11132, National Bureau of Economic Research, Inc.
  4. Julio Davila & Jay H. Hong & Per Krusell & Jose-Victor Rios-Rull, 2005. "Constrained efficiency in the neoclassical growth model with uninsurable idiosyncratic shocks," PIER Working Paper Archive 05-023, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  5. Daniele Coen-Pirani, 2004. "Shareholders Unanimity With Incomplete Markets," 2004 Meeting Papers 479, Society for Economic Dynamics.
  6. Patrick J. Kehoe & Fabrizio Perri, 2002. "International Business Cycles with Endogenous Incomplete Markets," Econometrica, Econometric Society, vol. 70(3), pages 907-928, May.
  7. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
  8. Junsang Lee & Yili Chien, 2008. "Optimal Capital Taxation Under Limited Commitment," ANU Working Papers in Economics and Econometrics 2008-498, Australian National University, College of Business and Economics, School of Economics.
  9. 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.
  10. Krueger, Dirk & Perri, Fabrizio, 2005. "Does income inequality lead to consumption inequality? Evidence and theory," CFS Working Paper Series 2005/15, Center for Financial Studies (CFS).
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  12. Dreze, J.H., 1984. "(Uncertainty and) the firm in general equilibrium theory," CORE Discussion Papers 1984026, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  13. Eva Carceles Poveda & Arpad Abraham, 2004. "Endogenous Trading Constraints with Incomplete Asset Markets," 2004 Meeting Papers 667, Society for Economic Dynamics.
  14. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.
  15. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
  16. Eva Carceles-Poveda, 2003. "Capital Ownership under Market Incompleteness: Does it matter?," Computing in Economics and Finance 2003 228, Society for Computational Economics.
  17. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
  18. Manuel S. Santos & Michael Woodford, 1993. "Rational Asset Pricing Bubbles," Working Papers 9304, Centro de Investigacion Economica, ITAM.
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Cited by:
  1. Krueger, Dirk & Perri, Fabrizio, 2010. "Public versus Private Risk Sharing," CEPR Discussion Papers 7625, C.E.P.R. Discussion Papers.
  2. Broer, Tobias, 2011. "The wrong shape of insurance? What cross-sectional distributions tell us about models of consumption-smoothing," CEPR Discussion Papers 8701, C.E.P.R. Discussion Papers.

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