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Complete Markets, Enforcement Constraints and Intermediation

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  • Arpad Abraham

    (University of Rochester)

  • Eva Carceles-Poveda

    (SUNY at Stony Brook)

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 Computational Economics in its series Computing in Economics and Finance 2006 with number 320.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:320

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Keywords: Complete markets; Enforcement Constraints; Intermediation;

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  1. Daniele Coen-Pirani & Eva Carceles-Poveda, . "Shareholders Unanimity With Incomplete Markets," GSIA Working Papers 2005-E13, Carnegie Mellon University, Tepper School of Business.
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  3. Patrick J. Kehoe & Fabrizio Perri, 2003. "Competitive equilibria with limited enforcement," Staff Report 307, Federal Reserve Bank of Minneapolis.
  4. DAVILA, Julio & HONG, Jay H. & KRUSELL, Per & RIOS-RULL, José-Victor, . "Constrained efficiency in the neoclassical growth model with uninsurable idiosyncratic shocks," CORE Discussion Papers RP -2463, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  7. Ábrahám, Árpád & Cárceles-Poveda, Eva, 2010. "Endogenous trading constraints with incomplete asset markets," Journal of Economic Theory, Elsevier, vol. 145(3), pages 974-1004, May.
  8. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
  9. 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.
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  13. 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).
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  16. Grossman, Sanford J & Stiglitz, Joseph E, 1977. "On Value Maximization and Alternative Objectives of the Firm," Journal of Finance, American Finance Association, vol. 32(2), pages 389-402, May.
  17. 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.
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Cited by:
  1. Dirk Krueger & Fabrizio Perri, 2009. "Public versus Private Risk Sharing," NBER Working Papers 15582, National Bureau of Economic Research, Inc.
  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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