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Asset Prices, Debt Constraints and Inefficiency

  • Gaetano Bloise

    (Department of Economics, University of Rome III)

  • Pietro Reichlin

    (Department of Economics, LUISS ‘Guido Carli’, CEPR and EIEF)

In this paper, we consider economies with (possibly endogenous) solvency constraints under uncertainty. Constrained inefficiency corresponds to a feasible redistribution yielding a welfare improvement beginning from every contingency reached by the economy. A sort of Cass Criterion (Cass, 1972) completely characterizes constrained inefficiency. This criterion involves only observable prices and requires low interest rates in the long-run, exactly as in economies with overlapping generations. In addition, when quantitative limits to liabilities arise from participation constraints, a feasible welfare improvement, subject to participation, coincides with the introduced notion of constrained inefficiency.

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Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 0803.

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Length: 26 pages
Date of creation: 2008
Date of revision: Mar 2008
Handle: RePEc:eie:wpaper:0803
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