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When financial imperfections are not the problem, but the solution

Author

Listed:
  • Arvaniti, Maria

    (CERE and the Department of Economics, Umeå University)

  • Carvajal, Andrés

    (University of California–Davis)

Abstract

The BP Deepwater Horizon oil spill of 2010 has focused considerable attention on the potential liability and the operating conduct of big oil companies. This paper shows that, limiting the ability of a company to insure and diversify its risks, creates incentives to internalize the welfare effects of catastrophic events, leading to a welfare improvement. We model an economy with complete financial markets where one agent’s actions impose an externality on other agents by altering the probability distribution of their risks. Then, a Pareto improved allocation can be reached via an asset reallocation, essentially restricting this agent’s choice of portfolio of assets. Hence, in the presence of externalities, disturbing the functioning of perfect financial markets can be socially beneficial.

Suggested Citation

  • Arvaniti, Maria & Carvajal, Andrés, 2016. "When financial imperfections are not the problem, but the solution," CERE Working Papers 2016:15, CERE - the Center for Environmental and Resource Economics.
  • Handle: RePEc:hhs:slucer:2016_015
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    More about this item

    Keywords

    externalities; financial markets; constrained suboptimality;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • Q50 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - General

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