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Endogenous market incompleteness with investment risks

  • Meh, Cesaire A.
  • Quadrini, Vincenzo

This Paper studies a general equilibrium economy in which agents have the ability to invest in a risky technology. The investment risk cannot be fully insured with optimal contracts because shocks are private information. We show that the presence of investment risks leads to under-accumulation of capital relative to an economy where idiosyncratic shocks can be fully insured. We also show that the availability of state-contingent (optimal) contracts – compared to simple debt contracts – brings the aggregate stock of capital close to the complete markets level. Institutional reforms that make possible the use of these contracts have important welfare consequences.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 30 (2006)
Issue (Month): 11 (November)
Pages: 2143-2165

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Handle: RePEc:eee:dyncon:v:30:y:2006:i:11:p:2143-2165
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Drew Fudenberg & Bengt Holmstrom & Paul Milgrom, 1987. "Short-Term Contracts and Long-Term Agency Relationships," Working papers 468, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
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  5. Vincenzo Quadrini, 2000. "Entrepreneurship, Saving and Social Mobility," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(1), pages 1-40, January.
  6. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2002. "Optimal Indirect and Capital Taxation," Levine's Working Paper Archive 391749000000000449, David K. Levine.
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  13. Quadrini, Vincenzo, 1999. "The Importance of Entrepreneurship for Wealth Concentration and Mobility," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 45(1), pages 1-19, March.
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