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Incomplete Markets, Transitory Shocks and Welfare

  • Felix Kubler
  • Karl Schmedders

Although equilibrium allocations in models with incomplete markets are generally not Pareto-efficient, it is often argued that quantitative welfare losses from missing assets are small when time horizons are long and shocks are transitory. In this paper, we use a computational analysis to show that even in the simplest infinite horizon model without aggregate uncertainty welfare losses can be substantial. Furthermore we show that in this model welfare losses from incomplete markets do not necessarily disappear when one considers calibrations of the model in which agent become very patient. We argue that when the economic model is calibrated to higher frequency data, the period persistence of negative income shocks must increase as well. In this case the welfare loss of incomplete markets remains constant even as agents' rate of time preference tends to one. (Copyright: Elsevier)

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Paper provided by David K. Levine in its series Levine's Working Paper Archive with number 2133.

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Date of creation: 05 Sep 2000
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Handle: RePEc:cla:levarc:2133
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  1. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
  2. Magill,Michael & Quinzii,Martine, 1992. "Infinite horizon,Incomplete markets," Discussion Paper Serie A 384, University of Bonn, Germany.
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  4. Judd, Kenneth L. & Kubler, Felix & Schmedders, Karl, 2000. "Computing equilibria in infinite-horizon finance economies: The case of one asset," Journal of Economic Dynamics and Control, Elsevier, vol. 24(5-7), pages 1047-1078, June.
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  7. Michael Magill & Martine Quinzii, 2000. "Infinite horizon CAPM equilibrium," Economic Theory, Springer, vol. 15(1), pages 103-138.
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  10. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
  11. Den Haan, Wouter J., 2001. "The importance of the number of different agents in a heterogeneous asset-pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 25(5), pages 721-746, May.
  12. David K. Levine & William R. Zame, 1993. "Debt Constraints and Equilibrium in Infinite Horizon Economies with Incomplete Markets," UCLA Economics Working Papers 703, UCLA Department of Economics.
  13. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
  14. David K Levine & William R Zame, 2000. "Risk Sharing and Market Incompleteness," Levine's Working Paper Archive 2080, David K. Levine.
  15. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  16. Manuel Santos, 1998. "Numerical Solution of Dynamic Economic Models," Working Papers 9804, Centro de Investigacion Economica, ITAM.
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