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Financial intermediation and the welfare theorems in incomplete markets

Author

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  • Marc Oliver Bettzüge

    (University of Cologne)

  • Thorsten Hens

    (University of Zurich
    Norwegian School of Economics
    University of Lucerne)

  • Michael Zierhut

    (Humboldt University)

Abstract

In production economies with incomplete markets, shareholders disagree about the objective of the firm. We show that a weak financial intermediary, who is unable to complete markets, can offer just enough spanning to resolve this disagreement. The intermediary is limited to offering one customized contract per consumer. Knowledge of demand functions is sufficient for offering the right contracts. Once agreement among shareholders is reached, productive efficiency is restored, which in turn permits a Pareto efficient market outcome. This result shows that the first welfare theorem does not depend on complete spanning, but merely on institutions that provide the right span. However, this cannot be said about the second welfare theorem: For some wealth distributions, equilibria with transfers fail to exist due to nonconvexities caused by market incompleteness.

Suggested Citation

  • Marc Oliver Bettzüge & Thorsten Hens & Michael Zierhut, 2022. "Financial intermediation and the welfare theorems in incomplete markets," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 73(2), pages 457-486, April.
    • Handle: RePEc:spr:joecth:v:73:y:2022:i:2:d:10.1007_s00199-020-01294-w
    DOI: 10.1007/s00199-020-01294-w
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    More about this item

    Keywords

    Incomplete markets with production; Shareholder unanimity; Financial intermediary; Firm objectives; Second welfare theorem;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis

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