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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
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  19. Huggett, Mark, 1996. "Wealth distribution in life-cycle economies," Journal of Monetary Economics, Elsevier, vol. 38(3), pages 469-494, December.
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