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The Welfare Cost Of Market Incompleteness: Optimal Financial Contracts With Non-Enforceability Constraints

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  • Vincenzo Quadrini, Thomas Cooley

    (University of Rochester)

  • Ramon Marimon

    (European University Institute, Universitat Pompeu Fabra, CEPR and NBER)

Abstract

In this paper we develop a general equilibrium model in which firms finance investment by signing long-term contracts with a financial intermediary. Due to enforceability problems, financial contracts are constrained optimal, that is, they maximize the surplus of the contract subject to incentive compatibility constraints. By comparing this model with an alternative model in which contracts are fully enforceable, we evaluate the quantitative importance of non-enforceability for the aggregate allocation of the economy. We find that in the steady state the welfare level in the economy with enforceable contracts is 2.6 percent larger than in the economy with non-enforceable contracts.

Suggested Citation

  • Vincenzo Quadrini, Thomas Cooley & Ramon Marimon, 2000. "The Welfare Cost Of Market Incompleteness: Optimal Financial Contracts With Non-Enforceability Constraints," Computing in Economics and Finance 2000 313, Society for Computational Economics.
    • Handle: RePEc:sce:scecf0:313
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